Short Commodity ETFs – Part 2: The move has begun
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The British Pound/US$ crossrate — In route to $1.4000
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Time to be short global commodity prices through ETFs
A trade with a $10 to $1 reward/risk relationship
Major reversal patterns are predominant in all global commodity indexes. The ETFs offer a trading opportunity with a $10 to $1 reward/risk relationship. I will take these types of measured-risk trade set-ups all day long.
Background
As shown by the long-term CRB Index, global commodity prices have been in an historic bull trend, with the Index advancing 107% from the late 2008 low and 269% from the 2001 low.
There is an old adage that, “Nothing cures high commodity prices like high commodity prices.” High commodity prices provide an incentive for manufacturers to find alternative and lower-cost production methods/components and for producers to bring new production on line.
There are some signs that commodity prices are overextended – and that significant price retracements are possible. In fact, H&S chart formations are appearing in all commodity-based ETFs.
Below is the daily chart of the iPath Dow Jones-UBS Commodity ETF (symbol: $DJP). A decisive close below $47.00 would complete this top and establish an initial objective of $41.64.
The ELEMENTS Linked to the Rogers Commodity Fund (symbol: $RJI) also exhibits a H&S top pattern. A decisive close below $9.20 would set a target of $8.15. Note on the charts of $DJP and $RJI the appearance of large down gaps on May 5. That these gaps have remained open is a sign of weakness.
Laying out a trade
I will attempt to establish a short campaign with a reward/risk relationship of about $10 to $1 using selected commodity index ETFs. Keep in mind that the sizing stated below is per each $100,000 of trading capital.
The London Stock Exchange trades a short commodity ETF, symbol $SALL (quoted in US$). I will buy 300 shares of SALL at $52.12 stop. My risk on the trade is $.80 per share, or a total of 24 basis points ($.80 per share times 300 shares equals $240). The target would be $57.80. If reached, my profit would be 170 basis points (or $1,704 per $100,000 of trading capital).
I will also short the Ultra 2X PowerShares DB Commodity Index ETF, symbol $DYY. I like the concept of being short the ultra-long ETFs because prices will erode if the underlying commodities drift sideways. Shorting an ultra-long ETF is similar to shorting an out-of-the-money call.
I have shorted the first layer of 200 shares today at $11.64 with a risk to $12.75 (22 basis points). I will short the second layer of 200 shares below the existing June low at $11.24 stop. If filled, I will risk the first layer to $12.22 (12 BP) and the second layer to $11.81 (11 BP). So, after two layers are established my total risk on $DYY will be 23 BP, or $230 per $100,000 of trading capital.
I will short a third layer of 200 shares of $DYY at $10.14 stop, and if filled I will risk my entire position to $11.06. This would lock in a profit of 11 BP in layer one and 3 BP in layer two. The risk on layer three would be 18 BP. The composite risk on all three layers of $DYY at the point of entry of layer three would be 4 BP.
The target of $DYY would be $7.15. If all goes according to the plan (and this seldom ever happens), my profit on the three layers combined would be 231 BP ($2,310 per $100,000 of capital).
I would anticipate that $SALL would be filled on the same day (+/- one day) as the third layer of $DYY. If all goes according to the plan, my maximum risk will be about 30 BP, or 3/10th of 1% of capital, and my profit potential is about 400 BP (or 4% of capital). Thus, my reward/risk relationship is at worst $10 to $1.
NOTE: If commodity prices rally from present levels and the symmetry of the H&S patterns is disrupted, then all aspects of this analysis and trading strategy will be nulified.
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Copper bear market continues to unfold
Silver is also setting up for a sell signal.
I last commented on Copper in a June 1 post titled, “Major chart top in Copper – Target is 360.” The bear flag identified in that post appears poised for completion. A move and close below the June 2 low of 403.25 (July contract) would put the finishing touches on the red metal. The chart below is a closing price chart — the close-only flag would be completed today by a close below 408. Such a close would have initial targets of the May 12 low at 385.35 and the November low at 360 to 365. The diamond top projects to 363.
In my opinion, if Copper has really rolled over (if the bull trend from the December 2008 low has run its course), the most likely target for a bear thrust on the weekly chart is the 2010 low at around 276. The bull trendline on the weekly log chart has been penetrated. Keep in mind that the violation of a trendline is not a signal in my trading, but simply indicates a change in a market’s behavior.
Selling Copper on weakness has not been a profitable manuever. If the flag is confirmed, Copper should be shorted on 700 to 800 point rallies.
A postnote on Silver. This market is setup to signal a H&S failure. I will short Silver if the June 3 low at 3506 is penetrated, risking about 50 basis points.
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July Soybeans — A Chart Lesson
The chart of July Soybeans is very instructive for traders using classical charting principles (Edwards and Magee or Schbacker).
As a starting point, no two classical chartists may label a chart in the same way. And even if some classical chartists agree as to pattern identification, it does not mean that:
- The pattern will be valid and not morph into something different, or,
- The traders will trade the pattern using the same entry and exit strategy, sizing and leverage, etc.
I had labeled the July Soybean chart as a 16-week symmetrical triangle. By the way, the morph rate on symmetrical triangles is quite high. Nevertheless, the pattern was mature enough that I bought the breakout on June 2 at 1402. My initial stop was based on my Last Day Rule principle (see Diary of a Professional Commodity Trader book for an explanation of this rule). The LDR price of 1383.6 was violated on June 7, stopping me out. I lost about 50 basis points on the trade.
I still have the chart labeled as the same symmetrical triangle, and view June 2nd and 3rd as a premature breakout — although the breakout could prove to be a bull trap of significant magnitude. I will receive a secondary completion signal if the market can clear the June 3 high at 1419.4 or close above the upper boundary line of the triangle (about 1404). As of this writing, July Soybeans are trading at 1402, not high enough to trigger an entry signal. If an entry signal is generated at the close, the new Last Day Rule will be the low of today at 1385.
I will go long on a secondary completion of the pattern with a risk of 50 basis points (1/2 of 1% of capital). If I go long again and get stopped out, I will no longer follow this market. I give a pattern two chances for a clean breakout.
There is another lesson in this market. I have recently written about my dismay with high/low bar charts because of the noise factor. I have a strong bias in favor of closing price charts. On a closing price chart, August Soybeans completed the symmetrical triangle on June 2, but has not violated the pattern. A close below the May 31 close at 1372 would be required to violate the pattern.
Using closing price charts raises the subject of not using intraday stops, but rather using “stop-close-only” orders (real or mental). I discussed this idea in my blog posts titled “Lessons from a difficult year of trading” on May 24 and “Stops or no stops – a response to StockSage1” on May 25.
From a tactical point of view, using close-only stops (or much wider intraday stops) means that a trader must downsize his or her leverage or sizing in order to limit the risk of a trade to a certain basis point loss. Ideally, while the profit potential per winning trade would decrease with smaller sizing, the win/loss ratio would improve over an extended period of time in a manner to hopefully offset the lower leverage per trade.
Well, that’s my brain drain on this subject for now.
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Silver: Going According to the Script – DOWN!
The markets whip me around often enough that I will take credit when I make a correct call…and my next call for Silver is DOWN.
Every once in a while a trader gets “in-step” with a market. And when that happens, a trader needs to ride that horse until the first time the horse bucks the trader off. At that point the trader needs to dust him or herself off and find a new horse.
On April 24, I posted the blog, “How do you spell bubble?…SILVER!” A chart included in the posting is shown below. In the posting I stated that the market was within weeks or even days of a major top. In fact, the high had already been made on April 25. On April 28 the market tested the high and the subsequent decline was historic.
On May 1, I posted the blog, “8 years of global Silver supply changed hands last week.” My conclusion was that a major distribution of ownership had occurred from the strong hands to the week hands. The chart I included in the post is shown below. The next day, May 2, Silver droped $5.65 per ounce at its low.
On May 10, I posted the blog, “Silver – What’s next short-term?” The chart from the post is shown below. My conclusion was that Silver would drop to new lows for the decline, then rally into the low 40s, then drop sharply.
I was correct on projecting new lows for the decline, but I think I was wrong on forcasting the rally into the low 40s. Earlier this week I posed the possibility of a 4-week H&S bottom with an extended right shoulder. While this is still a possibility, my preferred interpretation is that a H&S failure will occur. Extended right shoulders should generally cast doubt upon a H&S interpretation.
A H&S bottom failure occurs when:
- The pattern is briefly completed, but the advance immediately terminates and the trend preceeding the H&S bottom returns, or,
- A right shoulder rally falters short of the neckline and prices fall below the existing right shoulder low, completing the H&S failure pattern. [Note: I consider the H&S failure to be a pattern unto itself.]
The current chart of July Silver is shown, highlighting an idealized H&S failure.
I want to conclude with two points. First, neither the H&S bottom nor the H&S bottom failure have been completed. This market remains anyone’s guess. Charts are constantly evolving with one pattern morphing into the next, into the next, into the next, and on and on it goes. The real value (arguably, the only value) of charts is they provide traders with trigger points containing favorable risk/reward relationships.
Second, I am flat but would go long if the H&S bottom is completed or short if the H&S bottom failure is completed. Either event would be a tradeable signal for me. My bias is that the H&S failure will occur. The H&S failure formation would have a pattern target of 28.52 and a swing target of 21.58.
If the market continues to drift sideways in a choppy manner and then completes the H&S bottom, the chances are great that the H&S bottom completion will be a giant bull trap.
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Japanese Meltdown — Stock Indexes are Looking Radioactive
Major Japanese stock indexes are on the edge of the cliff
The charts of the major stock indexes in Japan are on the edge of the cliff. The Topix, iShares MSCI Japan Index Fund and Nikkei Dow are at critical support levels. Traders with Japanese exposure should watch these support levels carefully. A penetration below these support lines would indicate that the “dead cat” bounce from the March lows is over.
Trading strategy
The trading strategy I like best is being short the Osaka Mini Nikkei or short EZJ, the Ultra Long ETF. The global stock indexes are famous for bull and and bear traps. The Japanese market, especially, often generates a false signal just prior to a big move in the the other direction. So, I will be very flexible with these markets. Should I short the Japanese market (the mini Osaka or the ultra long ETF), and should the market reverse back to the upside, I will double up going long.
Commodity prices are topping now!
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Germany (via the Euro) has the World’s Cheapest Currency
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Major chart top in Copper — target is 350
Bear flag retest of diamond top is turning down
Two chart observations are worthy of note on the nearby daily futures graph. First, the decline in early May completed a 4+ month diamond top. This is a major reversal pattern. Second, the rally from the May 12 low is tracing out a bear flag. The decline today may indicate that the May 31 high will be the high of the flag.
The weekly chart of JJC, the Copper ETF, shows that the dominant trendline from the late 2008 bottom has been violated. Keep in mind, the violation of a bull trendline is not, in and of itself, a bearish signal. It does recognize that a trend change is in the process of developing.
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