Downward corrections in a bull market are inevitable and technical analysis is a proven and reliable means of identifying changes in direction.
Technical analysis is the study of market movement and its primary focus is on price action. Its strength and popularity comes from the assumption that future price direction can be predicted by studying a market’s past activity.
Price charts provide the easiest means of observing and studying market movements. Each day’s prices and the patterns which develop over time are the direct result of human decisions to buy and sell.
Studying the price movement and patterns therefore is an indirect examination of human nature in the marketplace. Since human nature does not change, it becomes reasonable to expect that behaviour, as reflected by price formations on the chart, will repeat.
Price history may also be examined to determine trend, as well as the price levels at which support and resistance to the trend may be encountered. As identified by the uptrending channel in the chart I’ve illustrated, the main trend is still up even though the minor trend has been down for the past two weeks.
The study of charts provides valuable insight to future price direction. This may sound simple, but remember chart reading is an art rather than an exact science and more often than not there’s plenty of room for personal interpretation. Everyday experience and a study of historical charts are important, but just keep in mind there are times when one simply does not know for sure until after the fact.
However, when reversal patterns occur at a new high for a move, they tend to be highly reliable indicators that the trend is about to change. When prices were at the peak, the May soybean futures contract had not one, but two two-day reversals materialize within five days of each other.
On the first day (at a top) the market advances to new highs and closes very strong at or near the high of the day. The next day prices open unchanged to slightly higher, but fail to make additional upside progress. Quantity selling appears early in the day to stymie the advance and prices begin to erode. By day’s end, the market drops to around the preceding day’s lows and closes at or near that level.
Market psychology: The two-day reversal is a complete change in sentiment. On the first day the longs are comfortable and confident due to the strong close. The market’s performance provides encouragement and reinforces the expectation for greater profits. The second day’s activity is psychologically damaging as it is a complete turnaround from the preceding day and shakes the confidence of many who are still long the market. The immediate outlook for prices is abruptly put in question. Longs respond to weakening prices by exiting (selling) the market.
Farmers who recognized these reversal patterns were able to look after their short-term cash flow requirements by making a sale just before prices collapsed. The validity of these reversal patterns was quickly confirmed when prices broke down below a key level of support, which was the previous week’s low ($13.70). This triggered sell stops resting under the market, which resulted in soybean prices closing down the daily allowable limit of 70 cents a bushel. Prices then went down to test and bounce off a key line of support, which is the lower boundary of the uptrending channel.
This conveys the point that charting and technical analysis often read like a roadmap by predicting the various twists and turns ahead, even in a volatile environment.
Just as the rally gave farmers an opportunity to lock in higher grain prices, lower prices are providing livestock producers with an opportunity to hedge their meal and feed grain requirements.
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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.