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Coffee - Context And The Danger Point. Technical Anatomy Of A Trade

Wednesday 22 August 2012

We do not often enter into the softs market, but a chart is a chart, and a trade is a trade. One should always start with higher time frames to develop a context from which to trade, depending on the trend,
for the trend is the number one consideration in knowing whether to be a buyer or a seller. It is from hindsight that a determination is made for moving forward.

Clearly, coffee began a bullish market from prior to 2006 to first part of 2010 trading range, with the start of a new rally beginning in June 2010. Markets are always testing and retesting previous areas of support and/or resistance, to one degree or another. What we know about the onset of a trend is that whenever it is retested, it is usually a safe area for initiating a trade. Two years later, June 2012, coffee is retesting the previous bull market breakout.

June has set the stage for a potentially successful retest. The low for that month stops right on a prior swing resistance high and then proceeds to rally and close strongly for the month, at the high of the bar range, above the opening for the month, and above the previous month's close. These are also all the earmarks of a key reversal at important support. What makes the support important is because of where it occurred, at the beginning of a bull market, 2 years ago. This should be a "safe" place to find a potential trade from the long side.

The differentiation is made because this trade is distinct from "bottom-picking," a much more subjective situation and not recommended. We are expressly looking to buy a potential retest and not trying to pick a bottom for the current down trend.

CFZ M 22 Aug 12

There is not always a similar/same support area between different time frames, so when they occur, they add greater significance to the support, or resistance in an uptrend. The weekly is providing greater detail of the monthly. A few things caught out attention. The first is the smaller ranges at the end of the move down, right into the identified support. Smaller ranges tell us that sellers are unable to extend the bar ranges lower, and that also means buyers are stepping in to match the effort of the sellers. The individual pieces of the "puzzle" are beginning to fit on place.

What follows next is a relatively stronger rally to the upside, erasing the selling efforts and volume from the previous weeks. If sellers were in control, that would not happen. The supply trendline is broken to
the upside. That denotes a weakening of the downtrend, but not necessarily the end of the trend, so we view it as a caveat only.

What we want to see next is a relatively weak correction of the June low. We also note that the June low holds mid-range in the down channel, and it does not reach the lower channel line, a relative sign of
strength, if one knows what one is seeking. The rally from the June low was three weeks. The decline from the rally high is in its fifth week, taking almost twice as long to retrace the gains, a relative sign of
weakness of the down trend. The "story," or pieces of the puzzle
continues to fit the retest scenario we are expecting to develop if
our premise is correct.

This is a finer point, but the strong rally bar, last bar for June, 9th from the end, can often act as future support, at the high of the range, the low, or somewhere in between. Because coffee is at the low of a
downtrend, the lower end of the range would be a more logical area to hold. Tuesday and Wednesday's lows are holding that level on a retest of the retest.

Remember, we stated a premise that markets are always testing and retesting previous areas of support and/or resistance, and we can often find attractive trades on the retests. Monthly and weekly charts are not used for timing, so we continue to the next lower time frame to see if the retest "story" is working.

CFZ W 22 Aug 12

Let us first look at the area being retested, from last June. Is it a likely area to hold a retest, now underway? We see how small the ranges were at the monthly, weekly, and now daily support lows. This is a form of stopping action for reasons already described. Buyers are taking everything sellers have to offer, thus preventing price from extending lower. The higher the time frame support, the stronger it is.
When consecutive time frames harmonize the same area, expect that support to hold, at least for some time, if not for a change in trend.

After the small ranges at A, we see a flurry of much wider ranges, telling us there is a battle going on between buyers and sellers at an area where sellers are supposed to be in control. The breakout rally
to the upside confirms sellers lost that battle.

Now we go back to the beginning when we said the higher time frames set the stage for context. Our expectations were for a retest of the previous bull market low to find a potential trade from the long side.
The context of each chart has been confirmed by successively lower time frames, validating the initial potential target area now under a microscope. We see reasons why "A" should hold a retest attempt in
the future, and that future is now.

What we are saying is that the trade we made today began two years ago, and subsequent activity has led up to it in a uniform manner. The activity from last June set the stage for today by virtue of how we
just described it as a likely area to hold. There is a method to all markets, if one has the patience to wait for them to develop. Of course, the same approach applies to all time frames, so a daily chart can be the equivalent of a monthly chart, and the smaller time frames commensurate to weekly and daily.

The failed probe lower at "C" lets us know that there was an attempt to go lower, but there were no sellers under the low of the previous day, and just weak stops, so no supply to worry about as "support"
is now showing up more and more. What we need to see is some reason to trigger a trade, and that would be another retest, at "D."
For that, we drill further into the intra day activity.

CFZ D 22 Aug 12

What caught our attention immediately for Wednesday morning's trade selection was the sharp increase in volume at the then low of the day. For intra day activity, volume is relative to that of the preceding
recent days, and this was the highest hourly volume in the past several days, [20 minute chart shown]. Price did not go lower or closer to last week's low. What the market is telling us, by its own activity, is that buyers were absorbing everything sellers had to offer. What then followed was an overlapping of bars, which you know is a battle between buyers and sellers at an area where sellers are supposed to be in control.

Here is the "danger point" in the trade, the last link of a two year process. It is a danger point because the buy is near the bottom of a sell-off that may have the "appearance" of a bottom-pick, but quite the contrary, it was/is the culmination of a series of bullish retests. Well, the trade can still fail and not be a culmination, but the probability of success in this caliber of trade is higher than many others. Ironically, the "danger point" is one that usually entails less
risk in a trade, as opposed to waiting for price to go higher for
additional confirmation.

Over a series of ten trades that have the quality of "story" and integral parts that fit over several time frames as this one does, a profit is almost guaranteed. Any single trade of the 10, including this one, can
fail, but the net balance of ten similar trades will be a success. The topic of a high probability selection process is one that cannot be covered in this analysis, but it is very important to successful trading.

How is the trade faring?

CFZ 20m 22 Aug 12

There was a slightly lower low. later on in the trading day, but the ranges were considerably smaller, and volume much less, telling us that selling pressure was not there. From that danger point low, coffee was
able to rally going into the close on wider ranges to the upside and increased volume, a show of buying interest.

CFZ 22m 2 22 Aug 12