Cocoa futures have rallied since a bottom extension in early October and have now made a top extension. This a good moment to point out a few things:
- Similar strings of market data don't always produce the same signal. These two charts are almost the same. They have three extension signals between them but no overlap. This is why we follow so many different markets (and instruments) as the signals are hard to generate. This distinguishes our approach from 'technical analysis' in which simple data is crudely crunched and similar versions usually produce similar signals
- Tops and bottoms are different and so signals that warn of them should be treated differently. Bottoms are more likely to occur as a single event, whereas tops more often form as a process. We generally take top and bottom extension signals as trades as soon as we see them but it is important to recognise this important difference - extensions mark the end of the prior move but not always the beginning of a reversal. Traders should behave accordingly.
As usual when we see a top extension, we now advise selling cocoa:
Grain markets remain soft and we have one half of a 'short corn' trade still in place. There are probably other opportunities to profit from some more weakness yet to come and so we have explored the alternatives. They are in wheat, soya oil and maybe cotton.
Wheat has compressed and dropped after a brief rally back up toward the compression. This looks to be a short-sale right now and even though we prefer to sell that secondary rally back toward the compression, the price has not fallen too far. The stop-loss would be placed the usual $1% away, rather than just the other side of the compression - in fact these two alternative ways of placing stops on compression trades produce very similar answers in this case.
Soya oil compressed and broke down, also providing a brief rally back up to the compressed level as a chance to sell it. That has only just occurred and so this is an opportunity to sell again (we covered a short very recently because of a 'time-out'):
Cotton also compressed and also dropped. It has since rallied back into the area of compression which we usually take as a chance to sell. A new compression has now formed however so we need to see a fresh downward break before we sell short. If it breaks upward, there may be a trade from the long side - we will advise.