From the April 01, 2011 issue of Futures Magazine • Subscribe!

Measuring wheat’s downward moves

Wheat prices began a steady climb when Russia banned wheat exports in August 2010 because of a poor harvest. Both Russia and India now are considering extending their wheat export ban. By February 2011, wheat prices climbed to near 2008 levels. Flooding in Australia and buying by Middle Eastern countries at that time supported elevated wheat prices. A drought in Chinese grain was looking dismal, but has since resolved, and the dollar decline also prodded wheat higher. Most recently, the catastrophe in Japan and improved weather conditions in the Midwest have been detrimental to price. "Breaking it down" (below) shows a daily wheat chart with a few technical setups for a short side position that would have yielded large profits.

Divergence: Divergence is a powerful filter to look for potential trades. In this chart, the MACD histogram is setting lower highs while price is setting higher highs. This is called bearish divergence and clues the technical trader to an imminent downturn in price. One also can find divergence using the CCI or RSI among other oscillators.

Trendline on RSI indicator and the midline: Classic charting utilizes momentum and trend indicators. You can tell a beginning trader by the numerous technical studies they have on a single chart. It is best to pick one favorite momentum (RSI, stochastic or CCI) and one trend indicator (MACD or DMI). My favorite momentum indicator is the old fashioned RSI. It’s banded by over-bought at 70 and over-sold at 30. It can drag along the top or bottom at these levels depending on the strength of the move. A major benefit of the RSI is the ability to draw support and resistance trendlines on it. As seen in the chart, the RSI broke its supportive trendline prior to the trendline break in price, thus providing either a good filter or actual trade entry.

A key point of the RSI indicator is the midline at 50; it acts as support or resistance. There are many fake-outs that often occur around this midline. Sometimes the RSI will dip just below 50, causing sell stops or new short positions to be filled. Then suddenly price will rebound. Likewise if crossing above 50, shorts will be covered only to see a resumed downward move. Be attentive when the RSI is near the midline. When the RSI moves staunchly through it, it denotes a change in momentum that makes for a great trade. Using smaller timeframes, 15-minute and 60-minute, can reduce, but not eliminate, fake-outs. These fake-outs wreak havoc on those using RSI midline strategies. RSI signals tend to be stronger when they are confirmed in multiple time frames.

Hand drawn channels: Observe the main trendline in “Breaking it down.” Channel lines equidistant above and below the dominant trendline based on a move away from the main trendline. For example, once a move above the main trendline tops, the upwards channel is drawn and the lower channel also is drawn based on the move away from the mean. The bottom channel, in this case, becomes a price target if price breaks below the main trendline, which it did and traded directly to the projected channel line. Price action loves equal distance moves.

Several momentum and trend indicators hinted at wheat's sharp downward correction that began in February. Click on chart to enlarge.image

"A closer look" shows how wheat broke a dominant trendline and went limit down, 60¢, the next day. Several indicators as illustrated in "Breaking it down," foretold this tumble.

Price broke the 20-day simple moving average but rebounded intra-day off the RSI midline 50 support. Lower lows and the 20-day moving average then became resistance. RSI broke its trendline and the midline at 50. Price closed below the dominant trendline and tumbled to the "measured move" projected channel bottom. It then made another "measured move" down to an even lower hand drawn channel at $7.00. Finally, it reached an oversold RSI of 30 and began forming a bullish MACD divergence where price is lower than the last swing low, while the MACD histogram is a higher low. This made a set-up for a possible buy.

Look for another test of the RSI midline and a move above the 20-day SMA to signal a stronger buy opportunity. The first target would be the orignial bottom channel and the next would be the main trendline broken on Feb. 18.

Layne Hermansen is an individual trader residing in Utah.

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