There are two entry strategies I like to employ when trading agriculture. The first, and classic, is to enter a position on a significant breakout to the upside – as we highlighted recently with regards to cotton futures.
This tried-and-true trend following play concedes the first 10-20% of a move, with the goal of catching the bulk of a run upwards. Since commodities, especially agriculture, tend to trend, this gets you in the trade if and when something begins to take off.
It’s been a successful strategy for me in the past, but I’m beginning to wonder if it’s become too popular and well-followed for its own good. With every hedge fund on the planet staring at the charts and moving averages, it’s likely that many are already in the trade by the time we would buy in – hence creating a lot of false breakouts we’re be buying into.
Entry strategy #2 – my new working theory – may solve this issue. If we wait until a commodity hits key support levels at the end of a downtrend, it is likely unloved and unowned. The downside of the trade is minimal, because you’d place the stop just below the current levels of support. Contrast this with a breakout, where you may not have support in the immediate neighborhood – nor a convenient place for your stop nearby.
Since we love commodities that are well off their highs – because the best cure for low prices is low prices – I’d like to highlight two particularly attractive candidates that are trading near key support levels.
Treat Me Rice
For the past two years, I’ve been writing about rice – focusing, in particular, on why rice should rally soon. While rice has been slowly trending higher since it most recently piqued our interest in 2011, we still haven’t seen an electrifying 2008-style pop.
After a recent “false start” to the upside, rice has dropped back into its recent trading range once again, and is sitting at support levels that have been twice successfully tested thus far:
Rice tests key support levels for a third time. (via Barchart.com)
Will price action finally reflect the projected favorable supply and demand fundamentals in rice? This is a nice setup to take a flyer on it.
Not to be confused with the original Birdman, the 2013 brand of cocoa appears to be drawing its own line in the sand just above the 2000. In fact, only once in the last five years has cocoa dipped below current levels – and that was in late 2008!
As you can also see from the chart below, cocoa is highly volatile, and should not be trusted to slowly consolidate and trend upwards. It’s a close-your-eyes-and-pray type of trade – one that may be best entrusted at these bargain basement levels.
Cocoa has solid 4+ year support at 2000. (via Barchart.com)
20/20 Hingsight: King Cotton
Back to the King – instead of waiting for the recent breakout above 78, we could have purchased cotton in the low to mid 70’s – with a stop below support – and bided our time. In this example, it would have worked out for us, as we’d have been able to hang in the trade until the breakout upwards.
A variation on this theme would have been to buy an earlier, and less refined breakout – so as to beat a few more funds to the punch, while ensuring that we are going long at the time it appears to be moving up.
More commodity coverage:
- Cotton’s gritty stealth rally kicks off
- Rogers Commodity Index swaps coffee beans
- IEA projects US to surpass Saudi as oil exporter by 2020