Technical Analysis Discussion

Chart Patterns. Bar charts are price charts that show the daily futures price opening, high, low, and closing using a vertical bar with ticks on it (see box above). Bar charts are used in technical analysis to analyze and predict the trend of prices. This is accomplished in a variety of ways, including a host of characteristic formations or patterns (e.g., "head and shoulders", double top or bottom, flags, triangles, etc.). In general, there is no research to show that these chart patterns determine prices or even reliably predict cotton prices. But many cotton market participants pay attention to them, and to the extent that traders act on them, chart patterns could occasionally beinfluential, in the manner of a self-fulfilling prophecy.

OHLC, Pivot Points, and Support/Resistance. Another common short term technical indicator is the daily price open, high, low, and close relative to previous days. Typically this latter information is used to derive so called "pivot points" (e.g., the average of the previous day's high, low, and close), which in turn are used to calculate expected primary, secondary, and tertiary resistance and support levels. There is nothing magical, theoretical, or intrinsically predictive about these calculated resistance and support levels other than that they are commonly employed by traders, which includes some very large speculative index funds. Both speculators and hedgers use calculated support/resistance levels to place buy/sell stop orders to exit their positions and limit their losses if the market goes against them. This predictably leads to concentrations of stop orders around certain price levels. The local floor traders at the NYBOT then make a practice of running the market up or down to trigger suspected batches of stop orders, thereby briefly extending the market move, and taking profits on their day trades. This phenomenon explains much intra-day market movements in cotton, and actually benefits hedgers in providing a lot of daily market liquidity. The disadvantages (to a hedger) are that your protective buy/sell stops might be triggered for these non-supply/demand reasons.

Moving Averages. In addition to chart patterns, many traders and analysts graph the moving averages of past price settlements to smooth out the choppy price patterns. Some analysts overlay a slower moving average (say, a 40 day like the blue line below) with a faster one (e.g., a 9 day like the red line below) to signal changes in trend that are harder to discern from a choppy bar chart. There is nothing intrinsically meaningful about moving average patterns other than that (and also that many people might be buying/selling according based on moving averages).

Retracement Percentages. Another technical indicator another involves expected sizes of corrections, usually involving threshold percent retracements, e.g., 38.2%, 50% or 61.8% retracement of a previous high or low. The 38.2% and 61.8% numbers reflect so called "Fibonacci" ratios, which are derived from numbers theory and reflect observed patterns of some natural phenomenon as well as some price patterns in financial markets. As with the previously discussed items, there is no economic theory or supply/demand rationale for why price patterns might follow a Fibonacci pattern. Still, it could be influential on the placement of a lot of market entry or exit orders, particularly if it coincides with other potential price thresholds based on moving averages, calculated support/resistance, or other technicals.

Summary Thoughts on Technical Analysis. Fundamental supply/demand factors are the long-run and over-riding determinants of cotton price movements. It should be obvious from the above discussion that I take technical analysis with a grain of salt. I am not aware of any current research showing the validity or reliability of various technical indicators as predictors of near-term cotton price movements. I do, however, have anecdotal evidence that many cotton brokers, speculators, floor traders, merchants, grower/hedgers, and index fund managers pay attention to technical indicators. And during the last four years I observed speculative buying or selling lead cotton futures futures either up or down between five and ten cents apparently based on little more than technical issues. If such price moves could hurt or help your marketing plan, then that is a valid reason for paying some attention to technical analysis.