Tim Walker
Tim Walker

Another commodity market that has had a spectacular run in the last 12-months is Coffee. The symbol for Coffee in ProfitSource is KC-Spotv. It trades on the New York Board of Trade, which is now part of the Inter-Continental Exchange (www.theice.com). Along with Sugar, Cocoa and Orange Juice, it forms the Food category of the futures markets.

Coffee futures have been trading for a long time in various forms. In Gann’s time there were two coffee contracts - ‘Santos’ and ‘Rio’. The current contract is known as ‘Coffee C’ or ‘Arabica’. There are five yearly contracts – March, May, July, September and December. The first trade in Coffee futures occurred on 7 March, 1882.

One contract of Coffee contains 37,500 pounds. The price is quoted in cents per pound, but the minimum fluctuation is 5/100 of a cent or 0.05. So the current price around 267.15 would be $2.6715/100s. A movement of 1 tick (or 0.05) is worth $18.75, which means a full cent movement is worth 20 times that (or $375).

If you are trading Coffee you want to be out of one contract and into the next one around the 20th of the month before expiry. This is how it works: The name of the contract (e.g. July) is called the delivery or expiry month. Each contract has what is called a ‘First Notice Day’. This is the date you stop trading it, unless you’d like to take delivery of 37,500 pounds of Coffee beans, that is! The First Notice Day is seven business days before the start of the delivery month.

The other thing you want to know is the Margin, which for Coffee is US$7,560 per contract. Remember that Margin has nothing to do with risk. It is simply the deposit which your broker holds while you are in the trade, to ensure that if you take a loss you have the money to pay it. At the end of the trade this is credited back to your account.

Right now (10 June) Coffee is sitting in an interesting position. First, let’s take a look at a long-term chart.

Chart 1 – Coffee Monthly

click chart to enlarge

This chart shows the movement of Coffee prices for the last 35-years. One of the great things about trading commodities is that they have big bull markets followed by big bear markets, which generally go all the way back to where they started from.

There are a couple of interesting things that we can see on this chart. Note that I have marked the current high in May, 2011 with a question mark. Could this be a major top? If you look at all the other tops, there doesn’t appear to be much room for prices to move higher, does there? In fact they are very close to a double top with the last top in May, 1997.

The next thing will be new to some of you, but look at the years when these major tops and bottoms have occurred. First the top I just mentioned in May, 1997 - from May, 1997 to May, 2011 is exactly 14 years. This is one of the cycles that Gann said to watch in markets.

Another that he used extensively was the 10, 20 and 30-year cycles. Note that in both 2001 and 1981, major turns occurred. They were lows, but we are interested in the fact that the turns were major. This is powerful evidence that something spectacular is about to happen.

Let’s take a closer look.

Chart 2 – Coffee Daily

click chart to enlarge

The 3 May top is the one you saw in Chart 1. There is currently a double bottom on 5 April and 2 June. A double bottom is a signal that prices will go up, so what do we read into this chart?

The first thing is that a break of this double bottom would be a signal that the main trend has turned down and you should be short all the way. But could you get short any earlier? Here are a couple of possible scenarios:

Firstly, you would measure the range from the 3 May top to the 2 June low. The 50% level of this range will be important to watch for any signs of a reversal. Also, keep an eye on the last top before the final high, which I have marked on the chart on 9 March. Prices rallying to that point would form what traditional technical analysts call a Head and Shoulders pattern. If you picture a body with a head in the middle and a shoulder on either side you will get the idea. This is regarded as a strong reversal pattern.

From this point you could look for ABC short entries, including on the weekly chart. A break of the double bottom would then be a signal to add to your position.

Spend some time playing around with the charts in ProfitSource. Look at the previous bear markets after major tops and work out how you could have traded them successfully and you’ll have a plan for the next few months.

Knowledge is Power!

Tim Walker