Live cattle and feeder cattle rallied to a new historical high last week. In reaching $150, feeder cattle prices achieved a technical measurement derived from a rectangle pattern.
Rectangles, or box formations as they are sometimes called, are found frequently on futures price charts. Most of the time, they are continuation, or sideways consolidation patterns, in which prices will pause for a duration of time without making progress.
As illustrated in the accompanying chart, a rectangle formation consists of a trading range which is bounded on both the top and bottom by horizontal lines. Within this sideways range, the price fluctuations must form at least two tops and bottoms. The pattern reaches completion when the price exceeds either the upper or lower boundary.
The completion of this rectangular pattern as seen on the chart became evident when prices exceeded an area of resistance at $120 in December 2010. A breakout of the sideways pattern is denoted as “A” in the accompanying chart.
A minimum objective is derived from taking the measurement of the height of the rectangular pattern and adding it to the breakout point, which in this case, is the horizontal line of resistance at $120.
In this example, feeder cattle had been trading in a $30 range between an area of support at $90 and a level of resistance at $120. By adding $30 to $120, the technical measurement gave ranchers and traders an objective of $150, which came to fruition 13 months later.
The breakout from a rectangle is considered to be highly reliable as a forecasting tool. A minimum measurement is determined by the vertical distance of the rectangle projected at the point of breakout. It is common for prices to exceed the formation’s boundary only to return to the pattern before moving in the direction of the original breakout.
Market psychology: Since the rectangle basically outlines a trading range, the buying and selling which comprises this pattern denotes support and resistance levels within the current price trend.
The upper horizontal boundary begins to form due to profit taking by longs, which turns prices lower. This decline in turn attracts bargain hunters.
The lower boundary represents a line of support where the demand, or buying of contracts, exceeds the supply. Similarly, the upper boundary represents a line of resistance where the supply of contracts for sale exceeds the demand, or buying of contracts. Between these two extremes the market is in equilibrium, with neither buyers nor sellers able to gain a lasting advantage.
Prices remain trendless for a time until either the buying at the upper boundary exceeds the selling, or the selling at the lower boundary exceeds the buying. When either occurs, the scales are tipped and prices break out of the formation.
When a rectangle develops in an uptrending market, one should realize that a breakout through the upper boundary not only cleans out the supply of contracts which had previously halted the advance, but it puts all shorts into a losing position. Similarly, in a downtrend, when prices break through the lower boundary of this formation, all longs are placed on the defensive.
To understand where, on a chart, the anxiety level of shorts or longs increases is very useful, for it is shortly thereafter that their contracts become fuel for the fire. A short-covering rally will drive prices higher, following a breakout to the upside. In the same way, a long liquidation break drives prices lower, when prices break below the lower boundary.
When chart formations form on a longer-term chart, like this monthly nearby feeder cattle futures chart, they take on a higher degree of reliability than on a shorter-term chart. This is extremely useful for providing ranchers, farmers and traders alike, with a reliable long-term perspective on price direction.
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— David Drozd is president and senior market analyst for Winnipeg-based Ag-Chieve Corp. The opinions expressed are those of the writer and are solely intended to assist readers with a better understanding of technical analysis. Visit Ag-Chieve online for information about grain marketing advisory services, or call us toll-free at 1-888-274-3138 for a free consultation.