Charting and technical analysis may be likened to reading a price roadmap where patterns form on the chart representing the road signs. If one is going to undertake a study of charts, it is imperative to learn the signs and what their implications are for prices. Classic formations, once identified, will point the way, signal caution, or alert you to a U-turn ahead. As with a roadmap, you begin by determining where prices are and where they have come from before deciding which direction they will take next.
While that may sound easy, there is an art to chart reading and there is more interpretation involved than exact science. The study of historical charts and experience are important factors in understanding the chart signs and patterns that ultimately lead you to discovering price direction.
With the above in mind, let’s take a look at the economic uncertainty the euro-zone countries are facing and see how their currency, the euro, is having an impact on the wheat market. Referencing the euro, I will illustrate how one can determine where wheat prices are going. Charting is an important tool that can alert you to the upcoming twists and turns in the price road ahead.
Reversal patterns (U-turns) develop at the end of an existing trend and upon completion indicate the trend has turned. As illustrated in the accompanying Japanese candlestick chart, aharami (sign) materialized at the height of the uptrending channel (path). The harami is a reversal pattern that may develop at the top of a rally (mountain top) or at the bottom of a decline (valley). This particular harami provided a sell signal following the conclusion of the highly publicized European summit in October.
One must constantly be on the lookout for a “buy the rumour, sell the fact” scenario like this. In this instance, the rumour was for a positive outcome to the summit, and the euro rallied. The fact was, the resolution only provided temporary relief, and the euro plummeted.
Continuation patterns such as channels (highways) illustrate the existing price trend and highlight the road prices are taking. After the harami signaled a 180-degree turn at the top of the hill (1.4235), the uptrend ran out of gas and prices rolled back down the hill to 1.2965.
Chart formations (signs) provide measurements (distances) and in turn price objectives (destinations). The measurement derived from the bear flag formation (sign) projected a price decline to 1.310. This price destination was achieved one month later.
In a downtrend, the flag stands at the bottom of a flagpole and slants upward in the shape of a parallelogram. When this chart formation forms quickly and compactly, it is considered one of the most reliable patterns for forecasting the next price move.
Market psychology: A brisk drop in price precedes the formation of a classic bear flag. The decline forms the flagpole. This is followed by profit taking, which causes prices to consolidate. The chart action tends to be minor, as prices rise and fall within the context of an upward bias.
A pattern of higher highs and higher lows develops until the profit taking has run its course. Then, new selling and the re-establishing of short positions turns the market back down. The lower prices attract more new sellers. The up flag pattern is completed when the selling drives prices below the formation’s lower boundary.
A projection for the next decline is arrived at by measuring the vertical distance of the flagpole and adding it to the point at which prices break down through the flag’s lower boundary.
As the euro declines in value relative to the U.S. dollar, it makes European-origin wheat more attractive to foreign buyers and North American wheat values drop to compete for market share.
Subsequently, another harami (U-turn sign) developed on Dec. 15, 2011, which indicated the euro was about to reverse back up, which is when wheat prices also turned up.
As you can see, Canadian grain farmers who have an understanding of where the euro is going, particularly as we shift to an open market system for wheat, are well positioned to take advantage of market moves that will allow them to sell their grain for more.
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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.