A Trading Lesson in Wheat4/10/2007 5:25:44 PM
By Alan Hall
The recent record freeze did not go unnoticed by the wheat futures market. Yesterday (Apr. 9), prices rose to a 5-week high in Chicago on speculation that the crop was damaged by the cold weather.
Many traders may think it was this possible freezer burn that caused traders to indulge in an irrational overreaction, and many may think the weather was an external event that moved the market. But the Elliott Wave Principle teaches that price moves are internal to the market, thus there had to be an internal bullish sentiment for wheat. Indeed, yesterday's Bloomberg article quoted a Kansas spokesman as saying that "the weekend freeze probably didn't do much damage…What the market did may not have anything to do with the damage."
Damage or not, wheat futures did rally on Monday morning. What's more, the rally invalidated the preferred Elliott wave count Daily Futures Junctures editor Jeffrey Kennedy showed last Thursday (April 5). Monday's move violated one of Elliott's three basic rules, "Wave four can never end in the price territory of wave one." This chart Jeffrey published last Thursday in his Weekly Wrap-Up helps understand the rule violation better:
As you can see, last Thursday the end of the fourth wave iv (green, circled) was only a couple of points below the end of i. (See the red line drawn across the end of the green, circle wave i?) The wave 1-4 overlap occurred Monday morning when wheat prices rose into the price territory of wave i (circled), invalidating the preferred wave count.
What good is an invalidated wave count to a trader? Well, much of the skill of successful trading involves knowing how to identify a high-potential trade setup and limit your risk at the same time. You must find a juncture in the market that shows both a high probability of a price move in a certain direction, and the opportunity to set a close stop.
Last Thursday, Jeffrey Kennedy thought he found just such an opportunity in Wheat. In this Weekly Wrap-Up video, he said that in order for his preferred, bearish, wave count you see in the chart above to stay valid, wave 4 had to stay below the end of wave 1. In other words, Wheat prices had to turn down immediately on Monday morning, because the critical resistance (end of wave 1) was only 2-3 points away. So a short position with a stop-loss just a few points above the end of wave 1 could have helped a skillful trader minimize the risk. In retrospect, we know that the trade wouldn't have worked, but the risk-reward ratio was outstanding.
If you've been trading for a while, you know that not every trade works. And taking a small loss can be as painful as taking a big one. But if traders don't pursue these kinds of limited-risk opportunities, they are likely to miss the major moves they are looking for. Helping you to identify these kinds of limited-risk opportunities is one of the real values of the Elliott Wave Principle.