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CHART ANALYSIS


Live Cattle's Cup with Handle Bottom

09/19/02 11:24:43 AM
by David Penn

Rebounding from a seven-month downtrend, livestock futures finally start moving up.

Security:   LCV2
Position:   N/A

One of the more helpful ways of looking at the CRB futures is to look at the subgroups, as well. Because of the weighting of the CRB Index, any given subgroup—from energies to agriculturals to precious metals to livestock—may be the one powering a bull market or leading the way down in a bear market. Additionally, the CRB subgroups are the "sectors" of the commodities market—much like sectors in the stock market. By analyzing the sectors, not only does a trader have a good sense of the market as a whole, but also a trader can find particularly good opportunities among the various constituencies of the subgroups.

An excellent example of this might be found in the livestock futures subgroup ($GVX). Note that the livestock subgroup has been in a downtrend since the beginning of 2002. In fact, the downtrend since 2002 is really the second leg of a downtrend that began in April 2001—as the chart shows. The chart of this approximately 18-month bear market suggests that livestock prices have fallen in the neighborhood of 27% from their spring 2001 peak. The chart also shows a major countertrend rally in the third quarter of 2001, which brought the livestock subgroup up some 18% before collapsing and resuming the downtrend in 2002.

Figure 1: Livestock futures have been trending down since April 2001.
Graphic provided by: TradeStation.
 
This longer-term view is helpful when considering the October live cattle futures contract, which has been forming a base for the past four months. Comparing the chart of the October live cattle futures contract to that of the livestock subgroup, note that while the subgroup put in a bottom in the second quarter of 2002 and a lower bottom in the summer of 2002 before rallying, October live cattle put in a bottom in the second quarter of 2002 and a HIGHER bottom in the summer of 2002.


Figure 2: October live cattle breaks to the upside in September after a four-month basing period.

The second higher bottom in the summer is the important one. Not only does it serve as the "launching pad" for the rally that begins in September, but also it provides support should the rally fail. The two-month consolidation in July and August makes it all the more likely that the lows of April, May and June are real bottoms.

The overall April to September consolidation has taken on an interesting cup with handle shape, as well. The cup with handle formation was popularized by William O'Neil in his book "How to Make Money in Stocks." Essentially, the cup with handle consists of a rounding bottom (the cup) that is followed by a small, brief correction (the handle) before prices move up and away from the formation. In the case of the cup with handle in October live cattle, the cup part of the formation extends from the beginning of April to the beginning of August, with the handle part of the formatoin extending from the beginning of August to the break on the upside in mid-September.


Figure 3: This weekly chart shows the resistance to the live cattle advance begins around 73.

The size of the formation suggests that October live cattle prices could likely advance to a nearby price target of 75. This comes from subtracting the formation low (63.3) from the formation high (69.2) and adding that difference to the value at the formation high. Looking to a weekly chart of October live cattle futures, we see that successfully reaching this price target would mean a new year-to-date high for live cattle.



David Penn

Technical Writer for Technical Analysis of STOCKS & COMMODITIES magazine, Working-Money.com, and Traders.com Advantage.

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