Chicago wheat futures have rallied early 25% since the end of September. Not coincidentally, commercial traders have come in as non-believers of this rally and have been selling for seven straight weeks. Their combined sales of approximately 40,000 contracts has been enough to turn commercial momentum negative and puts us on the lookout for short-selling opportunities. The recent rally is providing a textbook example of what we look for in our Commitment of Traders research.
A strategic approach can be explained in three easy steps. If it takes more than that to explain your strategy, you may be overcomplicating things.
Step One – Momentum
Only take trades in the direction of the commercial traders’ momentum. The bottom pane in the chart above shows that commercial trader momentum has turned negative. We’re actively looking for a short sale setup.
Step Two – Money Management
The second step is part one of money management. Commercial traders have very deep pockets. Successful traders are always seeking to maximize the risk to reward ratio. Therefore, we have to wait for the market to provide us with a small move against the commercial traders. This is more common than you might think. Commercial traders tend to trade in scale while speculators typically enter the trade with a single order. The wheat market’s rally has pushed our short-term momentum indicator into overbought territory. Our setup is triggered.
Step Three – Reversal Signs
The third step is the market must show some sign of reversal for us to enter. This provides us with two necessities. First, it keeps us out of markets that run away or go parabolic. Second, the market’s reversal will tell us what the swing high is and provide us with a meaningful chart point to place a protective stop. Currently, this is around $5.80.
There is solid resistance at $5.80 and $6.05 is the 50% retracement from the spring highs to the summer lows. While we expect the market to top out here and provide us with a short selling opportunity, we can’t jump in until the market actually reverses.
