As a technician and commodity trader I have been watching Coffee (Futures and ETF) for a few months. I’m not into the fundamentals of what moves this commodity, but the continuation chart of KC (Coffee Futures) tells a pretty clear story.
I do not what to waste your time going into useless (for trading purposes) analogies with the past – markets never completely repeat themselves- but it is worth to note how recently the price of Coffee approached an important zone of support at around 100-102. A decisive break below these levels is likely to bring Coffee to test the lower fifties. While if this level holds, the commodity can see some sort of rebound, if not a new bull market.
Zooming up into the weekly chart of Coffee Futures we find something incredibly nice for a Chartist – a little less nicer for a commodity trader, but let keep it for later.
We see a 48-week Failing Wedge that just got completed on December 13 when prices closed at 115.45/KCH. Look how the price bounced exactly at the psychological level of 100.95. Well, in my experience, that is even to nice to be true and I will not be surprised to see a quick spike below 100 just to hit the stops of those bought at 100 and protected them just a few cents below them. But this is not a good reason to do not take a trading setup. It is a good reason to just limit my risk on this trade to 50% or more of standard.
From a commodity trader standpoint, from the two previous charts we got important indications, that can be summarized in two bullet points:
1) We are at an important support level.
2) We just completed a multi-week failing wedge.
Wedges are not the most friendly classical chart pattern to trade because they have sloping trendlines. Ideally we would like to trade only patterns that have horizontal trendlines.
Let’s now look at the daily chart:
On the daily we see a small 37-day Ascending Triangle (also known as Couple and Handle pattern). This pattern was completed on December 13, when the futures market closed at 115.45 KCH. If you trade commodity ETFs, that correspond at 22.75/JO:
How would I trade this market?
1) Risking no more than 0.5 percent of my trading capital (or 50 basis points). This is an extremely risky trade so if usually I risk between 0.8 to 1.2 percent of each Unit of Capital, here I’d like to just risk half.
2) Choosing whether trade the futures of the ETF. This choice depends on two factors. Firstly, of course, to trade futures I need to have a leveraged account. Secondly, my trading capital should allow to buy 37,5000 pounds of Coffee without risking more that 0.5% of my trading capital in this trade. (Roughly if you are trading with less than $500,000 you should not be touching Coffee futures – unless you trade spreads).
3) Determining the entry and exit points. As for the entry, it is still safe to entry the market at this level. So, let’s assume that I buy Coffee on Monday’s open and the Monday’s open is equal to Friday’s close. Finally let’s assume that I trade the ETF because I trade Units of Capital that are smaller of $500,000. My entry would be at $22.64.
As for the exit, it is a no-brainer for me. I have a well establish trading strategy that I just need to follow:
- I set my Stop-On-Close Only (SOCO) at the low of the breakout day: since here we breakout with gap it is reasonable to look at the previous day close: 21.5.
- I set my Emergency Hard Stop (EHS) at a level far from the SOCO where the price should never gets, even in intraday movements. This level is 20.96: If the price reaches this level it means that I’m completely wrong and I would automatically exit this market with a loss.
3) Choosing my trading size. Here I have a simply proprietary formula. Let me explain to you. I give 50% of chances that my SOSO order get hit and 50% that my EHS fills. So, if I’m wrong on this trade I expect (that is my assumption) to exit this market exactly in the middle of my stops levels that is at 21.43. How I did that? Simply (20.96+21.5)/2 = 21.23. That is my Expected Exit (EE). Given that, plus my risk level (0.5% of trading capital) and my trading capital, the determination of the size is pure math. I my case I trade Units of Capital equal to $50,000, so I’m willing to risk $250 per Unit of Capital. The math would be like this: 250/(22.64-21.23) = 413 shares of JO.
Bottom line: on Monday I’d be buy 400 shares of JO (ETF) and when the order gets filled I would enter a sell 400 JO at 20.96 Stop Order AND a sell 400 JO at 21.5 Stop-On-Close Only Order, OCO (One Cancels the Other).