No Love For The Coffee Market?

Includes: JO
by: EconMatters

19 Months in the Downtrend

It has been a rough 19 months in the coffee market if you were long, and you had to be real nimble trying to trade the falling knife with some counter-trend trades. Coffee is currently trading around 1.41 per pound, and has been on a prolonged downtrend since peaking in May of 2011 at $3.12 a pound.

The coffee market is not as mainstream as many of the other more commonly traded markets. Accordingly, it is quite volatile, and many traders love its trending price action characteristics. The margins are higher to account for this increased volatility, and stops are an essential tool necessary for managing the position and protecting your trading capital.

Some basic facts about the market: Brazil is the world's largest coffee producer and exporter, while the U.S. is the world's largest consumer and importer.

No Inflation Here

We are finally getting back to the 10 year trading range; for all those inflation hawks, it depends upon when you look at coffee. Right now these prices sort of throw a bunch of cold water on the inflation thesis.

The chart looks absolutely bearish, and exemplifies the age-old economic axiom that there is no cure for high prices like high prices.

Kick a Commodity When It's Down

I think knowing a little bit about traders' psychology that they will try and push this lower to squeeze any diehard longs. Trend trading being rampant in commodities, they will really push this to find the absolute bottom, i.e., natural gas at $1.90 last year - they tried it twice to ensure that was indeed the bottom.

Remember Natural Gas at $1.90?

But just like Natural Gas, once the bottom is established this trade could be quite fruitful going the other direction, and the coffee market is worth watching for when the market finally turns and heads higher.

Key Support Areas

We are at some initial support at $1.40, but I want to watch it and see how this trades around that area as we still haven't had any pullback in markets at large.

I think there is a possibility that coffee ultimately tests the $1.20 a pound area where I am sure buyers will want to step in and test the waters here from the long side, as the $1 a pound level was established during the aftermath of the financial crisis selloff in December of 2008.

Positive Risk/Reward Setups

The risk reward parameters are starting to come together for a nice trade setup from the long side, now we must patiently wait for the correct entry point. Therefore, the coffee market has entered the phase where it bears close scrutiny; it first has to get to this stage, now we put it on probation, and study for signs of the bottom, and a high percentage reversal play.

We want to watch how it handles the key support levels and how it trades in this area - this is where watching price action of the instrument and putting in the chart dues every day pays dividends. A good trader develops a feel for the commodity in order to navigate through the cluster of noise that pervades almost every trading instrument these days.

Pull Up a Coffee Chart

So pull up a coffee futures chart and watch along with me, you never know when the next Natural Gas style reversal will come, but you have to start being prepared for the possibility ahead of time, as these can be some of the most profitable, and easy to manage trading setups in the markets.

Commodities Love the Trend Trade

Once you are profitable on a reversal, just keep moving your stop up conservatively, and catch a nice trending run if market conditions cooperate. If not, hopefully you picked a decent entry point, and you got stopped out for a small profit, and wait for the next long signal.

The Coffee Market Rarely Disappoints

There may be a couple of false breakouts, but from my experience in markets, it is only a matter of time before the coffee market reverses this bearish course, and makes another bullish run. It is just that kind of market, great for traders and well worth putting on your trading radar screens.