Since establishing a yearly low of $4.55 per bushel on Dec. 5, 2008, wheat prices have rallied to $6.16 per bushel, racking up an impressive increase, at the time of writing, of 35 per cent in just 15 business days.
Two chart formations materialized: a bear trap and a breakaway gap, early indicators of a bottom being established in the wheat market.
A bear is a trader who anticipates the market will go down. A bear trap catches this type of trader looking down at the bottom, anticipating the market will go even lower.
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Psychology of the market
Using the wheat chart to illustrate, you can see how the $5 price level proved to be an area of support for the wheat market for six consecutive weeks. When prices broke down below $5, short sellers eagerly jumped in and sold futures in anticipation of lower prices.
A short seller, also referred to as a short, is a speculator who has sold a futures contract and has a short position in the market. These traders make money when the market goes down and they lose money when the market goes up.
In this case, rather than prices going lower, they quickly rebounded above $5, and the shorts who sold futures contracts under $5 were caught losing money — hence the market formation’s name, bear trap.
Bear traps materialize and spring shut in a relatively short period of time. This one only took two weeks to appear on the weekly chart. Shorts were quickly caught off guard, with prices dropping below $5 one week and closing back above $5 the following week. This was followed by panic-type “get me out” buying the third week.
As short sellers bailed out of the market, buying back their losing short positions, this action resulted in the formation of a gap. A gap is a price range where no trading occurs. This type of gap, as seen on the chart, is referred to as a breakaway gap. These gaps occur just after the end of a sustained downward slide in price and are often considered to be a turning point.
The breakaway gap materialized when anxious short sellers, worrying all weekend about their losing positions, decided to bail out of their short positions. Their panic buying at the beginning of the week caused prices to gap higher, and as you can see, prices quickly reversed back up.
This type of bottoming action occurred while market news was very negative, and represents a classic example of how the news is always most bearish at the bottom.
The news has been incredibly bearish for the wheat market since the world produced a record crop of wheat in 2008. The U.S. Department of Agriculture’s Dec. 11, 2008 estimate was for a whopping 683.98 million-tonne crop, which surpassed the previous record of 625.74 million tonnes produced in 2004.
Fundamentally, a record crop would suggest record-low prices. However, that’s not so when you factor in the world’s consumption of wheat, which on Dec. 11, 2008 was estimated by USDA to be a record 655.99 million tonnes this year. As a result, world wheat stocks-to-usage ratios have only improved slightly from year-ago levels of 19.3 per cent and remain historically tight at 22.5 per cent.
By the time you read this article, USDA will have released its Dec. 31, 2008 final production estimates for 2002-07 field crops, and revised final estimates for 2003-08 stocks of grain and oilseeds.
Regardless of the fundamental information USDA releases with its revisions, the chart patterns indicate we have seen the seasonal low for wheat.
Join me online for an audio-visual presentation about this article and chart.
— David Drozd is president and senior market analyst for Winnipeg-based Ag-Chieve Corp. The opinions expressed are those of the writer and are solely intended to assist readers with a better understanding of technical analysis in the markets influencing agriculture. The information contained herein is deemed to be from sources that are reliable, but its accuracy cannot be guaranteed. Visit us online for more educational tools and ideas about grain marketing or call toll free 1-888-274-3138.
