Cocoa's Descending Triangle

03/14/03 09:42:42 AM

by David Penn

After failing to take out the October highs, cocoa looks poised to test the November lows.

Security: CCK03
Position: N/A

Cocoa futures--basis May--decisively broke through a two-month up trendline in February. The break was on contract-high volume, which signified a great deal of conviction on the part of the sellers. As I suggested in a recent piece ("Vouching for Volume," Traders.com Advantage, March 7, 2003), high-volume trendline breaks are important signals, but reading them accurately--as opposed to following them blindly--is key. In the example of platinum futures used in "Vouching for Volume," a short entry taken immediately after the high-volume trendline break to the downside would quite possibly have been stopped out as platinum reversed and proceeded to make a new contract high.

Here, a trader pursuing the high-volume breakdown in cocoa futures would not be as penalized. After dropping almost 130 points to a close of 2072 on the breakdown day, cocoa futures did in fact continue lower. But their descent has been stalled by the development of support at approximately 1950. This support level has held up for more than thirteen days. So while a short position following the high-volume breakdown would not have experienced signficant losses and would, in fact, still be a profitable position, cocoa remains stubbornly resistant to resuming its decline.

This descending triangle could anticipate a significant drop in cocoa prices.

Graphic provided by: TradeStation.

This stubbornness has taken the form of a descending triangle--or so it appears at this point (again, basis May). In addition to the horizontal support line at 1950, there is a diagonal resistance line that extends from the highs of February 24th at 2115 to the highs of March 12th at 2025. The descending triangle is a bearish formation, and can appear both as a top as well as a continuation or consolidation formation in a downtrend that has already developed. In this case, of course, the triangle is appearing as part of the downtrend that began when the most recent cocoa rally topped out in late January.

What sort of downside might be expected from a break in support in May cocoa? Assuming a downside break, the formation size of the descending triangle is 165 points which, when subtracted from the value at the support level (again, approximately 1950), gives a minimum downside target of 1785. While a move to this level would not in and of itself represent a test of the November lows (which stand at 1655), such a downswing would make for an 82% retracement of the advance from the November lows to the highs in late January (a 720 point advance followed by a 590 point decline). From the perspective of a cocoa bull, this suggests that it is quite possible that the entirety of the November to late January advance eventually might be retraced before cocoa prices begin to move upward again in any meaningful way. (Note that at 1950, cocoa has retraced approximately 59% of the previous rally.)

David Penn

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

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DESCENDING TRIANGLES

Cocoa's Descending Triangle

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