Analyzing charts should always start with price. The first thing to determine is whether price is trending or in a period of range consolidation. Major support and resistance levels should be assessed. Finally, indicators can be applied to give insight into the price action.
“Ready to reverse,” shows wheat futures in a downtrend. The downtrend is determined by the series of lower highs and lower lows. A falling wedge price pattern can also be seen and is outlined. A falling wedge is a bullish chart formation in a downtrend. It is characterized by price swings that fluctuate between converging resistance (supply) and support (demand) lines. Falling wedges show progressively decreasing range between support and resistance, meaning downtrend volatility is decreasing.
For the falling wedge lines to converge, one of them must have a steeper slope. In the wheat chart, the upper resistance line is steeper than the lower support line. This means that price swings to the downside are not traveling as far relative to price swings to the upside. There is less momentum to the downside. The downswing selling is being absorbed by buying at the support line. Since steeper trendlines are generally less stable, a breakout to the upside becomes increasing more likely.
The apex of the falling wedge in wheat is nearing a level of prior horizontal support at $7.28. The closer price gets to the support level, the more likely price will stop and reverse. Short positions are generally covered at major support, and new buyers often use support levels to resume trades from the long side.
Now that price has been analyzed, we can add the ADX (Average Directional Movement Index) indicator to better frame out the trade setup. ADX confirms the downtrend is currently strong. However, the ADX of the downtrend is not as strong as the strength of the previous uptrend. This suggests a breakout can occur to the upside on a V-type trend reversal.
The negative Directional Indicator (-DI) shows that the sellers are still in control. However, the last –DI high was about equal to the previous –DI high, while price made a lower low than the previous low. This is “positive” –DI divergence and suggests the downtrend is losing momentum and ready to reverse. The current downtrend is weakening and volatility is decreasing. Price is nearing support, and an upside breakout from the falling wedge may occur in the near future. A long entry should not be made until price breaks above the resistance line. Breakouts from falling wedges tend to pause and test support before making a larger move up, so don’t be in a rush to enter.
Charles B. Schaap is a commodity futures strategist. He is the author of “ADXcellence — Power Trend Strategies” and “Invest with Success — Big Profits for Small Investors.” His Web site is www.adxcellence.com
