Soy Meal/Bean Oil Spread: A Short Position Reinstated Our Reversal System Campaign

Soy Meal/Bean Oil Spread

For the last couple of months, we have been waiting patiently for a rally to materialize in the December soy meal/bean oil spread. The hope was that we’d see a rally back to +$13,500 (premium meal) so we could initiate a short position. Since the spread had spent several months oscillating back and forth over the +$13k mark, the trading plan was to initially get short on a rally and then implement a reversal system.

Initially, we figure the rally would be just one last ‘hurrah’ before the soy meal/bean oil spread rolls over and heads back down to the ‘even money’ area. However, a clean breakout to new highs could set the stage for a stellar return to the 2014 summer high of +$24,726 on the weekly nearest-futures chart. Either way, we expect a move of several thousand dollars per spread.

December Soy Meal Bean Oil spread daily

December Soy Meal Bean Oil spread daily

After today’s big acreage report came out, the grain markets exploded higher. This elected the entry criteria on the short side. The blog theoretically sold one 100-ton December soy meal soy meal contract at $340.70 (a contract value of $34,070) and simultaneously bought one 60,000 lb. December bean oil contract at 34.01 (a contract value of $20,406). This opens up a short position at approximately +$13,664 (premium meal).  Time will tell if we were the smart money who sold the rally up here or if we really stepped in it.  Either way, we have a plan to trade both sides.

We are going to exit this short position and simultaneously initiate a long position on a close above +$15,500 (premium meal). If that happens, we will use a close back below +$13,500 as our criteria to reverse back to a short position again. For now, we will leave parameters in place to trade the December soy meal/bean oil spread with a reversal system. Simply put, we will always be long on a close above +$15,500 and always be short on a close below +$13,500.

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Feeders/Live Cattle Spread: The Short Sale Signal Was Triggered Today

Feeders/Live Cattle Spread

A lot has happened in the last eight days. Last week the October feeder/live cattle spread closed less than $100 away from the January 5th high of +$49,410, which is currently the high for 2015. Today it closed at a two-month low. Switching from a multi-month high to a multi-month low indicates that the tide has turned in favor of the bears.

Today’s close below price support at the May low of +$46,890 (premium feeders) triggered the hypothetical sell signal for the blog. A short position would have been initiated by selling one 50,000 lb. October feeder cattle at 212.075 (a contract value of $106,037.50) and simultaneously buying one 40,000 lb. October live cattle at 150.725 (a contract value of $60,290). This opens up a spread position at +$45,747.50 (premium feeders).

October Feeder Cattle Live Cattle spread daily

October Feeder Cattle Live Cattle spread daily

Initially, we will risk a two-day close above +$49,820. This is $500 above the June top.

As we’ve mentioned before, this spread has over $25k to go before it returns to a historically normal level. The October feeder/live cattle spread has a lot of profit potential on the downside. We will be watching to see how things unfold. If we’re lucky, a few countertrend rallies along the way may provide us with setups to add to the short position. We shall see.

Cocoa/Sugar Spread: Raise the Short Sale Level

Cocoa/Sugar Spread

The nearest-futures cocoa/sugar (x2) spread posted a new contract high of +$7,791.20 (premium cocoa) on June 15th. This was the highest weekly closing price since September 1986 as the spread made it slightly past the major double top on the weekly timeframe between the 2008 high of +$7,258.80 and the 2002 high of +$7,771.60.

Cocoa Sugar (x2) spread nearest-futures weekly

Cocoa Sugar (x2) spread nearest-futures weekly

Historically, prior instances where the value of one cocoa contract was worth more than the value of the sum of two sugar contracts have been followed by major trend reversals. The smallest decline that followed drove the cocoa/sugar (x2) spread back below -$15k (premium the sum of two sugar contracts). The declines that followed the similar 2002 and 2008 tops ran the spread to -$28,492 and -$45,915, respectively. So we know that the reversal, when it comes, should offer plenty of profit potential for the savvy short seller.

On the daily timeframe, the September-October cocoa/sugar (x2) spread has made a higher monthly high and a higher monthly low for five consecutive months. The spread has held technical support at the rising 30-day Moving Average as well. Since early February, there has only been one instance where the spread closed below the 30-day MA.

September Cocoa October Sugar (x2) spread daily

September Cocoa October Sugar (x2) spread daily

A two-day close below the 30-day MA for the first time since the start of February would signal a bearish trend change for the September-October cocoa/sugar (x2) spread. A break of a prior month’s low would alter the bullish price structure. Either one of these events is good enough for an entry signal on the short side, while the next one to occur will be viewed as the confirmation.

Trade Strategy:

Cancel the current hypothetical order in the September-October cocoa/sugar (x2) spread and replace it with a new order to sell one 10-ton September cocoa contract and simultaneously buy two 112,000 lb. October sugar contracts if the spread makes a two-day close below the 30-day MA (currently around +$4,362) or a one-day close below the June low at +$2,378 (premium the sum of the two sugar contracts), whichever occurs first. Initially, the spread will be liquidated on a two-consecutive day close $500 above the contract high that precedes the entry.

 

RBOB Gasoline/Crude Oil Spread: Revise the Short Sale Parameters

RBOB Gasoline/Crude Oil Spread

The September RBOB gasoline/crude oil spread reached a new one and a half year high of $24.52 this morning, putting it just a buck and a half away from the December 3, 2013 contract high of $25.98. Also, today will mark the fifth-consecutive month that the nearest-futures RBOB gasoline/crude oil ratio finishes above 1.4:1. The prior record was three months. As we’ve noted before, previous excursions above 1.4:1 have always been followed by collapses to 1.15:1 or lower. The fact that the gasoline/crude ratio has been elevated so long could indicate that the inevitable reversal is going to be a doozy. The longer it takes, the bigger the break.

During this multi-month rally from the January low, the September RBOB gasoline/crude oil spread has only broken a previous month’s low once. Therefore, the June 22nd pullback low of $21.43, which set the low for the month, is an important near-term price support level.

September Gasoline Crude Oil spread (75-day MA) daily

September Gasoline Crude Oil spread (75-day MA) daily

Furthermore, the spread has closed above the rising 75-day Moving Average every single day for five months straight. The pullback into the early April low (the only time this year that a prior month’s low was breached) ended just above the 75-day MA. If the September RBOB gasoline/crude oil spread makes a two-day close below the 75-day MA for the first time since late January it would signal a bearish trend change. Coincidentally, the 75-day MA should be at or above the June low within a week. Therefore, a two-day close below the 75-day MA will likely be accompanied by a break below the June low. This ‘tag team’ trend change signal could be the catalyst for a major decline. We’ll take it as a green light to get short.

Trade Strategy:

Cancel the current hypothetical order in the September RBOB gasoline/crude oil spread and replace it with a new order to sell one 42,000 gallon September RBOB gasoline contract and simultaneously buy one 1,000 barrel September crude oil contract if the spread makes a two-day close below the rising 75-day MA (currently around $21.10) or a one-day close below the June low of $21.43, whichever occurs first. If filled, the spread will initially be liquidated on a two-consecutive day close 20 cents above the 2015 high that precedes the entry.

 

Platinum/Gold Spread: Revise Purchase Parameters For July Trading

Platinum/Gold Spread

Another month has rolled by and the platinum/gold spread once again made a lower monthly high and a lower monthly low. At the June 22nd contract low of -$123.20, the spread has spread wiped out three-quarters of the entire run from the 2012 record low to the 2014 double top. Unless a reversal pattern materializes, the spread remains on track for a return to a double bottom at the nearest-futures record lows at the December 7, 2011 low of -$218.90 and the August 10, 2012 low of -$219.80.

The October platinum/gold spread finds important overhead resistance between the declining 75-day Moving Average around -$62.30 and the June high at -$68.20.

Platinum Gold spread nearest-futures daily (75-day MA)

Platinum Gold spread nearest-futures daily (75-day MA)

A two-day close above the declining 75-day MA for the first time since early August and a close above a previous month’s high for the first time since March and only the second time during this bear market would alter the bearish price structure. This would signal a bullish trend change and, quite likely, the end of the bear market. Therefore, we will continue to use this as an entry signal to get long.

Trade Strategy:

Cancel the current hypothetical order in the October platinum/gold spread and replace it with a new order to buy two 50/oz. October platinum futures contracts and simultaneously sell one 100 oz. October gold contract if the spread makes a two-day close above the declining 75-day MA (currently around -$62.30) or a one-day close above the June high of -$68.20 (premium gold), whichever occurs first. If filled, the initial liquidation plan is to exit on a two-consecutive day close $5/oz. below the contract low that precedes the entry.

The 2016 Grain Basket Spread: Placing Bets On a Crop That Doesn’t Even Exist Yet

The Grain Basket Spread

Most commodity traders are trading the closest delivery month contracts in the futures markets. This is where most of the liquidity is. Rightly so. The closer deliveries are more sensitive to changes in supply and demand. This causes them to move around more than the back month futures contracts. The greater market volatility often means more trading opportunities. However, trading opportunities can sometimes materialize in the distant-month contracts where they are seemingly hidden from the majority of traders. These opportunities develop under the radar as most traders don’t usually even monitor the distant month futures contracts, much less trade them.

We are of the opinion that some lucrative trading opportunities may currently be shaping up in distant delivery month futures contracts. Specifically, we are examining the grain markets. Here’s what we have ‘bean’ looking at:

Grain Markets: The ‘Big Three’

Our focus will be on three different grain markets: soybeans, corn, and wheat. Soybeans are the second-largest crop in the United States, corn is the largest crop in the United States, and wheat is the fourth-largest crop in the United States.

(Attach the weekly soybean, corn, and wheat overlay).

Soybeans Wheat Corn overlay monthly

Soybeans Wheat Corn overlay monthly

As you might expect, the relationship between soybeans, corn, and wheat is highly correlated. These grain markets have similar growing seasons (wheat actually has an additional growing season as well so both spring wheat and winter wheat are planted and harvested during the year) as they are planted in the spring and then harvested in the fall. So if a summer drought affected the beans it most likely harmed the corn and wheat, too. And if ideal growing conditions produced a bumper crop in corn then beans and wheat probably didn’t come off looking too shabby, either. This causes grains to generally trend in the same direction. Other factors such as the overall health of the global economy, demand for bio-fuels, and currency exchange rates have an impact on grain prices as well.

On the other hand, there are times when fundamental events will have a great impact on one particular grain crop and a muted influence on the other two. For instance, a summer drought in Russia may not directly hit corn and beans while it decimates the wheat crop. And if weather problems in South America cause demand for US soybeans to surge it may not have a direct impact on corn or wheat. These sorts of events can cause disparities in the relationship between grain markets, some of them quite significant. The disparities tend to be temporary, though. Several decades of price history reveal that the relationships between these three markets are consistently very strong. In past occurrences where the three markets experienced a divergence it was only a matter of time until they got back in sync. It has always been a question of ‘when’ and not ‘if’ these three amigos get back together. These strong correlations can lead to some great trading opportunities in the grain markets.

Spreading a Basket of Grains

We are analyzing the spread between soybeans and the sum of wheat and corn. We like to call this the ‘grain basket’ spread. To establish a long position in this spread one would need to be long one soybean contract, short one wheat contract, and short one corn contract for each spread position.

The price of the front month July soybean contract is trading about 31 cents over the sum of the price of the July wheat contract and the July corn contract. This is nothing spectacular. Since we are only interested in the spreads that hit levels that are historically extreme, we would simply pass this one by.

Historically, we consider the spread “cheap” when the beans trade at a discount of $1.50 or more under the sum of the wheat and corn. Conversely, we consider the spread “expensive” when the beans trade at a premium of $2.00 or more under the sum of the wheat and corn.

Grain Basket spread nearest-futures weekly

Grain Basket spread nearest-futures weekly

Since the 1960s, there has been only nine times when the spread made it to the upper level of $2.00 or more (premium beans) and about half a dozen times when the spread made it to the lower level of -$1.50 or less (premium the sum of wheat and corn). Most occurrences ultimately led to a reversal that send the spread back to even money and beyond. These were profitable opportunities for sophisticated traders who knew the way this grain basket spread operates.

Rationing the Grains in the Basket

Over the last few years, we’ve seen the grain markets skyrocket to historic highs. Three years ago, the US experienced the worst drought in over half a century. This propelled beans and corn to highs never seen before in history and wheat reached the second-highest price on record. Price extremes can cause the spreads to look extreme as well. To normalize the data, we compare the grain basket spread to the grain basket ratio. This tells us if we are really dealing with a high-probability trade opportunity or if we are just being fooled by price extremes on the underlying market sector.

Grain Basket ratio nearest-futures monthly

Grain Basket ratio nearest-futures monthly

Based on nearly forty-five years of price data, the ratio between soybeans and the sum of wheat and corn is expensive when it climbs 1.4:1 and it is cheap when it drops to 0.85:1. The ratio has only neared or reached this upper boundary half a dozen times in nearly half a century and it has only experienced the low side of the ratio five or six times in the same period.

Hidden Far Into the Future(s)

Currently, the July grain basket spread is at +31 cents (premium beans) and the July grain basket ratio is at 1.03:1. This is middle-of-the-road levels. As we stated before, it is of no interest to us.

July Grain Basket spread daily

July Grain Basket spread daily

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Now here’s something that will make you sit up and take notice: the spread between the 2016 November soybeans and the sum of the December 2016 wheat and December 2016 corn is trading at -88 1/2 cents (premium the sum of wheat and corn). This is $1.19 lower than the nearest-futures July 2015 spread! Although it has not reached the historical extreme of -$1.50 yet, it has been heading that way and it’s a heck of a lot closer than the 2015 spreads are. The Nov-Dec 2016 grain basket spread has dropped about 67 cents from the mid-June peak. If this spread drops another 62 cents from here it will hit the -$1.50 mark.

Nov-Dec 2016 Grain Basket spread daily

Nov-Dec 2016 Grain Basket spread daily

What’s interesting is these are the 2016 new crop contracts, meaning that they won’t even been planted until next spring. So the growing price imbalance in this spread is for something that doesn’t even exist yet.

Nov-Dec 2016 Grain Basket ratio daily

Nov-Dec 2016 Grain Basket ratio daily

The low spread on the 2016 new crop grain basket is confirmed by the ratio. The ratio hit 0.91:1 this morning, which is just a stone’s throw from the 0.85:1 qualifying level.

(Attach the daily Nov-Dec 2016 grain basket ratio).

When to ‘Go Against the Grain’ and Be a Buyer

Examining the daily chart of the Nov-Dec 2016 grain basket spread, we see that this is the sixth time in the last seven months that the spread has dropped to -65 cents or lower. The previous five times, it never closed below -65 cents for more than two days in a row before making a sharp recovery.

This time something has changed. Not only did the spread break price support between the similar December and early June lows, but today could also mark the third day in a row with a close below -65 cents. This is a bearish breakdown.

Currently, we are cheering for a drop to -$1.50 or lower. This would officially qualify the Nov-Dec 2016 grain basket spread as a trade candidate on the long side.

From a pattern-driven outlook, though, a trader could look to go long if the bearish breakout fails. We like to call this the Wash & Rinse signal. It’s where a market cracks price support at a prior low, sets off a bunch of sell stops and algorithm-based sell signals, and then promptly turns right back around. This often leads to a sharp rally. It works in the outright markets and, surprisingly, works just as well in the spreads.

Keep Calm and Trade On

Even if the spread continues to plunge, we know that history indicates that prices at the boundaries on the historic low side don’t last. Especially since the crops for these particular delivery month contracts don’t even exist yet and they won’t even be planted this year! These three crops can be interchangeable from a planting perspective since a lot of acreage can be used to plant beans or corn or wheat. So if the spread/ratio between beans, corn, and wheat is still extremely low when the spring of 2016 rolls around then what farmer is going to want to plant soybeans?! They would obviously have a much higher profit margin in wheat or corn.

But what if the grains see their normal seasonal decline in the next couple of months? Maybe there’s a chance of seeing these long-dated spreads continue to rack up new contract lows. Or what if the Russians ban wheat exports or the Australian wheat crop is destroyed by drought while beans and corn just sit there? This could hammer the spread as well. Perhaps. Or perhaps not. But the important point is that extreme lows like this just don’t last in the grain spreads. The irrevocable Law of Supply and Demand will see to it that the imbalance is corrected. Even if the rally fades and the first attempt at a long position is exited at a loss, the probabilities have not changed. As a matter of fact, they may actually increase since the time duration at such an extreme low will have increased as well.

How to Trade This Spread…And All Spreads

To weather and unforeseeable storms, traders need to exercise sound position-sizing rules (never add to a losing position!) and risk management principles (never bet the farm on any one trade!) in order to stay afloat. Don’t led greed cause you to put on a position size that‘s much larger than is prudent. And don’t let fear or thoughts like ‘it’s different this time’ prevent you from getting back up if the spread gets knocked back down. Stay cool and use common sense. If you can survive the short-term adverse moves, you will be around to capitalize on the long-term probabilities.

Trade Strategy:

For tracking purposes, the blog will make a hypothetical trade by buying one 5,000 bushel November 2016 soybean contract and simultaneously selling one 5,000 bushel December 2016 wheat contract and one 5,000 bushel December 2016 corn contract if the spread between soybeans and the sum of the wheat and corn closes above -70 cents (premium the sum of the wheat and corn). If filled, we will initially risk a two-day close of 5 cents below the contract low that precedes the entry.

The S&P 500: A High-Probability Buy Setup For Contrarians

The S&P 500: High-Probability Buying Opportunity

The IMC blog is focused on one strategy: Spread trading. However, I am going to go off topic here and bring up a trade setup in the stock market. This one’s a dandy. I have used this very same setup to successfully catch some monster moves in the stock indices, so I thought I’d share it with readers.

Darkest Before the Dawn

The world woke up to some ugly news this morning. The bailout talks in Greece failed. Capital controls were implemented as they shut down their banks and stock market for a week. This smashed stock markets everywhere and sent Treasuries soaring on flight-to-quality buying. It also edged Chinese stocks lower, which was just enough to bring it down 20% or more from the peak. Chinese stocks are now officially in a bear market.

Market Turning Points

The timing of all this chaos is interesting. This week is one that I have often considered one of the most important potential turning points of the year. First, let me define my term of what a ‘turning point’ is. It is not an anniversary of a prior market high or low. It is not something that has to do with planetary alignments. It is not a Fibonacci time count. By my definition, a turning point is a timeframe that has a higher-than-normal probability of a major market move. This could be a price breakout, a price trend acceleration, or a price reversal.

There is no mystery behind my turning point dates, either. I simply look at scheduled fundamental events where market participants have to make a decision about their positions. End of month, end of quarter, and end of year are times when money managers have to decide if they want to book open profits or losses for performance records. First Notice Days, Last Trade Days, and options expirations are times when futures traders have to decide if they want to roll contracts, take deliveries, or book the P&Ls on their positions. Markets holidays leave traders vulnerable since the markets are closed and they will be unable to react to any sudden fundamental events that occur during this period. Therefore, they must decide if they want to lighten up on their market exposure, hedge their positions, or take a risk and hope nothing goes awry. The more of these events that happen in the same time period, the higher the probability that it could be a turning point.

This week is the end of the month, the end of the quarter, First Notice Day in several July futures contracts, and a three-day holiday weekend in the US for Independence Day. (I could mention the full moon on Thursday, but I won’t!). That’s a lot of stuff going on. Therefore, this week’s price action is worth paying attention to.

The Gap & Fill signal

In response to the Greek turmoil, the S&P 500 futures market opened sharply lower in overnight trading and this morning. The opening price was well-below Friday’s low, which also happened to be the low for last week. This creates a ‘gap down’ open on both the daily and weekly timeframes.

E-mini S&P 500 Weekly

E-mini S&P 500 Weekly

A ‘gap’ open indicates strong sentiment in the market as traders rush to buy or sell at any price available. This can lead to acceleration in the direction of the opening price. However, it often marks the end of a move since the panicked traders dump all of their position at once.

I like to use the gap open as a contrary indicator. However, I would not advocate buying a market just because it gapped lower on the open. I also would not short a market just because it gapped above the prior day’s high on the open. The key is to follow the market and get in only if it starts to confirm our suspicions by rallying after a ‘gap down’ open or sinking after a ‘gap up’ open. Personally, I like to wait for the market to return to the prior day’s low plus a couple of ticks to close the gap before buying (or drop to the prior day’s high to close the gap before selling after a gap up). I call this a Gap & Fill trade. Not very creative name, I know. But what do you want more: A high-probability trade setup or a fancy name?

Just for the record, I cannot take credit for ‘inventing’ or ‘discovering’ the Gap & Fill pattern. Many well-known successful traders have made it an important part of their trading arsenal and some of the algo guys try to keep it in their Top Secret proprietary models. I learned this pattern at least fifteen years ago from a mentor and it continues to work even today.

Titling the Odds Even Further

The Gap & Fill pattern works well enough on its own merit. But I like it even better if the pattern triggers either side of technical support/resistance levels such as moving averages, Fibonacci retracements, old highs/lows, etc. This indicates that support/resistance is doing its job and increases the probabilities that the reversal will hold.

I also like to see it occur during turning points or high-probability seasonal timeframes. For example, although it was gut-wrenching, I was able to successfully catch some of the bottoms after major corrections in the stock market when it gapped down to/below major support in the Q4 timeframes and then reversed higher. Autumn is when major lows are often established in the stock market. Each market has a time of the year, time of the month, and, in some cases, even a time of the week when highs or lows are more likely to be established.

Very Important Point

Once the gap has been filled and the position is entered in the direction of the gap close, a trader should immediately place a protective sell stop just below the low of the decline that preceded the rally (or a protective buy stop just above the high of the rally that preceded the decline). If the market reverses again after the gap is filled and a new low/high is made, you need to take your lumps and get out of harm’s way. Something bigger is afoot. Trading is all speculation, but I can make one guarantee: If you trade without a stop/exit point, sooner or later one trade will come along that wipes you out completely. You must manage risk!

Today’s Setup

Criteria 1: The September S&P 500 futures contract opened below Friday’s low this morning, creating a ‘gap down’ open on the daily and weekly charts.

E-mini S&P 500 Daily

E-mini S&P 500 Daily

Criteria 2: The market neared technical support between the May 7th reaction low (and low for the month) and the widely-watched rising 200-day Moving Average.

Criteria 3: This gap down into a support zone is occurring during a high-probability turning point week. Therefore, a recovery from here could indicate that an important low in the stock market has been established.

Trade Strategy:

To trade the Gap & Fill, place a buy stop order to buy a September E-mini S&P 500 contract at 2087.25. This is one full point (four ticks) above Friday’s low. If filled, place a protective sell stop two full points below this week’s low.

Aussie/Kiwi spread: Cancel the Buy Order For Now

Australian Dollar/New Zealand Dollar Spread

About two months ago, the Australian dollar/New Zealand dollar spread reversed off of a fifteen-year low and closed above the declining 50-day Moving Average for the first time since early November. This triggered a bullish trend change. In response, the IMC blog put out a hypothetical trade alert to go long on a small pullback to the 50-day MA and a Fibonacci .382 retracement.

Australian Dollar New Zealand Dollar spread (continuous) daily

Australian Dollar New Zealand Dollar spread (continuous) daily

In hindsight, waiting for a small pullback was a bad idea. The spread did not quite reach our entry level. Instead, it rocketed several hundred basis-points higher for the next several weeks. At the June 23rd seven and a half month high of almost nine cents (premium Aussie), the Australian dollar/New Zealand dollar spread has left us in the dust.

Since our initial entry level is now so far away, it seems that the prudent thing to do right now is to simply cancel the order and keep this spread on the watch list.

Trade Strategy:

Cancel the hypothetical order to buy one September Australian dollar/New Zealand dollar spread at 2.60 cents (premium Aussie).

Live Cattle/Lean Hog Spread: Short Sale Signal Triggered

Live Cattle/Lean Hog Spread

On Monday the December live cattle/lean hog spread closed at a new contract high of 95.12. Three days later, it closed at 91.85. This 3.27-cent pullback off the highs is the largest pullback that has occurred since the mid-April correction low was established. It also triggered the blog’s entry criteria to get short on a pullback of three cents (3.00 points) or more (on a closing-basis) from the watermark high.

The IMC blog made a hypothetical trade by selling one 40,000 lb. December live cattle contract at approximately 152.47 and simultaneously buying one 40,000 lb. December lean hog contract at approximately 60.62. This opens a short spread position at 91.85. Initially, we will liquidate the spread on a two-consecutive day close above 95.62 (.50 points above the contract high).

December Live Cattle Lean Hog spread daily

December Live Cattle Lean Hog spread daily

If the December live cattle/lean hog spread closes at a price of 92.85 or less today it will post the first weekly loss in nine weeks and alter the bullish price structure. This would corroborate the current overbalancing of price on the daily timeframe. After that happens, we will be pulling for a two-day close below the rising 20-day Moving Average (currently around 89.95) for the first time since the first half of May and a close back below the March 23rd top at 89.62 (old price resistance, once it has been broken, becomes new price support). Once this occurs, the bearish trend reversal in the December live cattle/lean hog spread should be solidified.

Trade Strategy:

The blog is still working a hypothetical ‘add-on’ order to sell one 40,000 lb. December live cattle contract and simultaneously buy one 40,000 lb. December lean hog contract if the spread closes below 80.00 (premium cattle). Initially, risk the ‘add-on’ position to a two-day close above 85.00.

The price parameters for this ‘add-on’ trade could be changed if the price pattern between here and there lends itself to a better setup. We will certainly post an update if this turns out to be the case. It won’t be the only ‘add-on’ trade that we do, though. Since the 20-cent area is a historically normal level for the live cattle/lean hog spread to return to, we want to take full advantage of the bear market potential by actively looking for additional ‘add-on’ opportunities.

 

Feeder Cattle/Corn Spread: Short Sale Signal Triggered

Feeder Cattle/Corn Spread

Yesterday the September corn contract finished a two-consecutive day close above the declining 50-day Moving Average for the first time since late March. This triggered a high-probability bullish trend change signal. For the last two years, using a two-day close above/below the 50-day MA to signal a trend change has been highly accurate and also profitable for traders who used it for entry and exit signals. As a matter of fact, the bullish trend change signal in March was the only one that failed to produce a profit for traders using it as a reversal system. All of the other trend change signals experienced follow through for months afterward.

September Corn

September Corn

Today the corn market exploded to a two-month high and cleared a prior month’s high for the first time this year. This altered the bearish price structure on the monthly timeframe and confirms the trend change.

Furthermore, the October feeder cattle contract traded at ‘limit down’ today before bouncing just a bit at the end. It still closed below the rising 50-day Moving Average for the first time in over two months. It also cracked the uptrend line that was drawn across the February 25th contract low and the mid-April correction low.

October Feeder Cattle

October Feeder Cattle

The combined bearish signal in the feeders and bullish signal in corn caused the October-September feeder/corn (x6) spread to crash below the support level at the similar November top, the May top, and the June 8th pullback low and close below the rising 50-day Moving Average for the first time since the start of March. This triggered the hypothetical short sale signal for the blog.

October Feeders September Corn (x6) spread daily

October Feeders September Corn (x6) spread daily

The short position was entered by selling one 50,000 lb. October feeder cattle contract at 215.70 (contract value of $107,850) and buying six 5,000 bushel September corn contracts at $3.82 3/4 (a total contract value of $114,825). Therefore, the position is short from -$6,975 (premium the sum of the six corn contracts). The initial exit criteria will be to liquidate on a two-consecutive day close above -+$4,300 (premium feeders).

Feeders Corn (x6) spread monthly

Feeders Corn (x6) spread monthly

Although it is disappointing to see that the entry was triggered on a breakdown to a two-month low, the profit target still justifies it as a worthwhile trade. Historically, the feeder/corn (x6) spread has usually gone back down to -$60k or lower after rolling over from multi-year highs. That’s about $53,000 lower than today’s close. If ‘add-on’ setups occur along the way, this is the sort of trade that can make a trader’s year.