Wow, what an exciting week! I just love this time of the year as the markets start moving and showing some direction.

We nailed a lot of the markets last week and our Pick of the Letter Cattle trade is working out great as well. This last week has also seen a lot of other markets setting up quite nicely for us to trade this week. In spite of war tensions at home and around the world, things are good. We’re definitely on a roll…and hopefully we’ll keep on rolling! ;-)

Sometimes it’s easy to forget how fortunate we really are. I was going to use this week’s Bull Section to gripe about the rising cost of gas and the increasing taxes and government involvement, but I can’t. As bad as things get sometimes I have to consider myself pretty fortunate: I live in a great part of the world, I’ve got a wonderful wife, I’m doing something I love to do, and best of all I get to share some of what I know about trading with you each week in this ezine. To me, it just doesn’t get any better than that.

Well maybe it does. Those of you who use Gecko Charts, the same one’s I use in the ezine, (for a free trial click here) already know about the Gecko Charts’ Trade Show that is being held in Las Vegas Saturday, March 15th from 9 am to 5 pm at Caesar’s Palace.

Not only will you be able to browse the various displays and meet fine folks like Lan Turner the President of Gecko Software, but you’ll also meet some of the people you’ve already have come to know and respect like Tom Loge’, Kirk Kristian and Scott Barrie. If that isn’t good enough, the icing on the trade show cake is that Gecko has also lined up a full day of speakers to lecture on various aspects of trading.

Best of all, it’s FREE (but you should RSVP so they know how many people to expect). Don’t let the price tag fool you though, there is plenty of valuable information to be gleaned and important contacts to be made at a trade show like this.

The trade show sounds like a lot of fun (hey, it’s Vegas) and I’m planning on being there. If you’re able to get away I think it would be worth your while to attend as well. If you’d like more information you can email Gecko Software at sales@geckosoftware.com.

While I’m on the subject of presentations, allow me apologize for the mix up in my PalTalk presentation last week. As you know I was supposed to do a presentation at the Common Sense Commodities PalTalk site; however at the last minute David cancelled the presentation. I’m still not entirely clear why he did that, but to avoid similar problems in the future we will be setting up our own chat room for future presentations. That way no one will be disappointed.

We’ve got another great ezine for you this week. Hope you enjoy this issue.

Corn continued to rally last week on concerns over the weather and possible moisture problems for this year’s crop. However the rally subsided by the end of the week as forecasts for rain over the holiday weekend turned the market slightly bearish. While it is not unheard of to see corn rally at this time of the year, this rally might have come a few weeks earlier than usual.

We’ve got a fair amount of resistance over the market at 246 and now that the gap of January 8th has been filled I think we might see corn prices pullback next week, but only for the short term.

Look for the market to find support nearby at 238 ¾ or 237 ½ before corn likely resumes the uptrend. Even if the market falls below 237 ½ it is unlikely that it will gain enough momentum to break the support of the recent lows at 231 ¼.

Once the market closes above 246 we will likely see prices continue higher to the scattered resistance found between 248 and 252 ½ with harder resistance to the top side of this range. We will likely see a bounce off the resistance in this area as the market makes its way to the 50% retracement target at 266.

Cotton prices continued to climb last week setting a new contract high before the weekend. Traders attributed the rally to March contracts rolling over into May with the added buying helping to support prices. However, in spite of the market’s continued rally there are cracks developing in the armour that would suggest that a downturn is around the corner.

For the short term I wouldn’t be too surprised to see cotton continue higher. If the market can get above the nearby weekly resistance at 5800 it is likely that the market will continue on to the next resistance at 6004 where we will likely see it reverse.

While it is tempting to long the market as there is about $1000 profit potential between the two resistance points, the market seems to be running out of room to the long side and I would probably favour waiting for a signal to establish a short position. If you feel you must go long however, it is probably advisable to keep tighter stops as the market might reverse prematurely.

Once we do have a signal to short the market look for it to make eventually make its way to the 50% retracement level. Assuming the market has enough upward momentum to get to 6004 the 50% level would be at 5415, which coincidentally has a fair amount of support.

Harvesting delays in the soybean regions of South America coupled with slow farmer selling is said to have halted the slide in bean prices last week. Yet while beans appear to be mounting a rally they are still confined to a large trading range which has held this market in check since last September.

Long term outlook for beans is very bullish as we are quickly approaching the planting season in North America. However, I wouldn’t get too excited about any rally until it is in a position to challenge the contract highs and I’m not sure the current rally has the strength to do that.

In spite of some nice gains last week the market seems to be stalling as it reached the 573 mark. While it appears that the market is resisting going lower there is resistance just above the current highs at 576 which the market will have to deal with before it goes any higher.

Above here things get a little more interesting since the market should be in a position to challenge the contract high at 588. This is also the top of the trading range which has held the market down these last six months so it will be an important price point to test.

If the resistance at 576 once more turns the market around it won’t have far to go to find support. Initial support is found just below the market at 565 followed by support at 556. While I would not expect the current market to get any lower than this point, if it did look for support at 550 to hold the market up.

What a great move in cattle for us! A quote from one of the market new agencies said that “Wednesday's tumble in the futures market caught many traders off guard, and one analyst Thursday morning said the market appears to be in a liquidation phase with more to do. Further declines in futures could add pressure to cash markets, he said.”

I love stuff like that. As you know I’ve been calling for lower cattle prices for the last couple of weeks now, yet traders always seem to be “caught off guard” when the market behaves as the chart says it’s supposed to!

While last week’s bounce off the #2 point of our 123 top formation was shorter than anticipated the market bee-lined to the support at 7500 before bouncing again at the end of the week. From here I would expect to see the market rally slightly next week getting as high as the resistance at 7670 or maybe 7710 before once again returning to the downtrend.

Once the downtrend resumes look for the market to re-test the support at 7500. Once the market is below 7500 it should try to complete the 50% retracement of the major uptrend at 7338; however that is likely another week or two off in the future.

For more analysis on the Cattle market check the Pick of the Letter section in the ezine.

Continued uncertainties in the political environment helped support cocoa prices for another week. The market is flirting with some pretty substantial highs and while it has not given a clear signal that it wants to go lower it has likewise not indicated that it is ready to go higher at this time either.

We could use the contract high (2395) and the high of last week (2375) and this week (2353) to trade the market as a triple top. Normally triple tops are very strong formations and in most cases the market retreats from them, so that is the preferred set up for cocoa this week.

Stochastics are showing the market is overbought and is picking up some divergences which help confirm the validity of the triple top. Likewise momentum indicators seem to suggest that the market seems to have lost some of its original momentum; however that alone is not enough to send prices lower.

A break below the current support at 2257 should signal that the market is heading down for the near term. Once below the current support the market should challenge the support at 2170 on its way to the 50% retracement at 2015.

If the market exceeds the current highs it is possible that the uptrend will continue to the weekly resistance at 2470, 2575 and 2775. The more ambitious among you might want to bracket the market between the current highs and the support at 2257; thereby entering a market on a breakout to either side; however given the overbought situation of the market and the fragile fundamentals driving the cocoa market right now I would be hesitant taking a long position at this time.

Sugar prices did not do a whole lot last week and continued to hover near the contract highs. Prices were buoyed by news that Brazil, one of the world’s largest sugar producers, will be cutting back on exports to allow more sugar to be used in the production of fuel alcohol which is a gasoline additive.

Technically speaking the market is up against some significant weekly and monthly resistance around the 795 – 800 mark. While I don’t believe we will see a full reversal in sugar prices just yet, we might be seeing the beginning of a reversal pattern forming.

If the current highs hold, which I expect they might, look for prices to retreat over the next few days to support at 755, 737 or maybe even 716 (but I doubt it). Once the market has tested the support at the 755 or 737 level it will in all likelihood continue higher and once more test the upper resistance at 793. If the highs at 793 continue to hold then we can expect to see lower prices follow.

While it appears that the current highs will hold there is no denying that the market is in a powerful uptrend. Should the 793 highs fail the next stop seems to be weekly resistance at 835 and 860; however given that the market is extremely overbought and upward momentum is falling I would be hesitant about taking a long position at this time.

As in week’s past, the talk of pending war in the Middle East has helped support the Swiss Franc; however it appears that the market has run out of buyers and might be due for a short term retracement. While I do not believe that the market has shifted entirely from bullish to bearish, there is a definite change in market momentum.

As the bulls try to force higher prices they are doing so on thinner volume, whereas the bears are gaining lower prices on increasing volume. This trait is characteristic of a head and shoulders formation which hints that the market may have found a top, at least for the short term.

Look for a break below the lows of 7276 or ideally below the resistance of 7266 as a completion of the formation. From here expect prices to decline to support at 7220 before possibly reversing and testing the breakout line at 7266 – 7276. There would be more support near the 62% retracement line at 7170 which could reset the market back on its original bullish course; however ideally the market will attempt at 50% retracement at 7077.

Of course if the market does not break below the 7276 – 7266 support and instead violates the current contract highs all short bets are off. In such a scenario look for the market to continue higher to the next resistance found on the weekly chart at 7555 and 7600; however given the market’s current condition, a move to the short side seems more feasible.

The poor performance of the stock market coupled with weakening industrial demand for precious metals sent silver prices plummeting last week. The market wasted no time breaking through support levels and showed no sign of stopping until finally finding support on Friday at 450. It is difficult to say at this point whether silver has finished declining or whether it will continue lower next week.

If the market does break support at 450 it will continue lower to nearby support at 445. If the market breaks 445 then it will very likely reach the lows at 434.50 as well; however Friday’s trading seemed to suggest that the market may hold at the current level.

Silver is normally a market that rebounds after a quick decline, which is what I think we can expect to see next week. Once the market has found its footing, either at the current low of 450, or the support at 445, look for the market to test resistance above Friday’s high at 465 early next week. While we might see a mild bounce here I believe that we will eventually see prices continue higher to the 50% level of the recent downtrend at 475.

You see, the market is retreating from the support at 7500 as we expected it to. Right now there are a lot of traders who are long this market who are beginning to seriously re-consider their position. Likewise there are a lot of traders who were looking to short the market and they’re kicking themselves that they missed their opportunity to get in at a good price. Therefore both groups are driving prices higher so that the traders who are long can get out and cut their losses and the traders that were interested in going short can enter at a price that still offers good profit potential.

So what price is that? My guess is that we will see the market pull back to resistance at 7665, right to the top of the gap. If the market has a lot of upward momentum we might even see the market test resistance at 7710, but I seriously doubt it will get past that point. I have moved the stops for both contracts to 7785, just above last Wednesday’s high.

Watch the market daily to see that it continues to take out the previous day’s high. The day the market fails to make a new high will likely be the extent of the pullback and it might occur before the 7665 level, so be prepared.

If we were trading a larger account I would be tempted to add another contract at this point, but with the smaller account I would refrain. However if the market makes a small range prior to reversing I might take advantage of it and add a contract at this time below the lows of the range with all stops above the high of the range.

Otherwise I plan to add a third and final contract below the 7500 support at 7484. We want to be prepared just in case the market makes another fast move down like it did last week. Note that if I take a short order from the pullback point, assuming the market sets up with a small range first, I will remove the additional order at 7484. Again if I were trading a larger account I would probably leave that order in place; however given our account size I would limit my exposure to three open contracts.

As we are getting closer to our target of 7338, it is a good idea to place our exit order when the third contract is engaged. Since I don’t want to be too greedy and want to be ensured exiting at a good price, I would place an exit order for all three contracts at 7356, just shy of the 50% retracement target.

Hopefully this week will be a kind to us as the last two weeks have been.

-Erich

Here are this week’s comments and a an answer to a question I think is really an important concept for everyone to be very clear on.

MARCH SWISS FRANC

As currencies have a tendency to do, the Swiss Franc has been in a long term trend to the upside. It is beginning to show signs that the run may be over as Erich points out. However, the weakness of the dollar could keep the Swiss in a range near the highs … we already have a pretty good channel going from mid January. An option might be just the tool for current conditions. The March options expire in just 19 days so we must move out to June options, September is a bit too far I think.

It’s a little pricey, but the best spread I see is to BUY the June SF 72 PUT and sell the June 70 PUT. You should be able to buy this spread for about 60 points or $750. Our maximum risk then is $750 plus 2 commissions. Our max reward potential is $2500 (the difference in dollars between the strike price bought and the strike price sold) less the $750 or $1750. This gives us a Risk to Reward ratio of 1:2.3 … marginal at best.

Our management plan would have us risking no more than one half the $750 or $375. If March SF traded thru 74 I would exit the spread and probably escape with less loss than even the $375 depending of course on how much time passes before it gets to 74. At $375 risk we have a R/R ratio of 1:4.7. We would exit the trade with profits if March SF trades to Erich’s 7077 goal. At this level we’d most likely NOT see the full $1750 but it should yield a profit of about $600-800. Certainly acceptable.

MAY COCOA

May Cocoa options have 47 days to expiration. This might be enough, but , I think I prefer going to July where I have 75 days. I’d buy the July 2200 PUT and sell the July 2000 PUT for a debit of about 70 points or $700. Again risk only one half the debit or $350. The maximum profit potential is $2000 less $700 or $1300.

This is a little less than a 2:1 reward to risk but jumps up to 3.7:1 on the managed risk of $350. I’d be gone if May Cocoa trades thru 2375 probably losing less than $350 and I would take profits on a trade of May Cocoa at Erich’s target of 2015 and I would be watching it very closely when it approached the support at 2135.

JULY SUGAR

I really like this chart. The risk/reward in a short futures trade is so small I think I would do a contract here. My “ACTION NUMBERS” FOR July Sugar being a sell at current price level, a stop at 798 and an initial profit taking target of 737. Given we closed Friday at 785 my risk on a futures contract is only 13 points or $135. For smaller traders or for those who have a healthy respect for Sugar’s ability to make surprising moves you might consider buying the July 800 put and selling the 700 put.

You should be able to buy this spread for 40-45 points or about $500 plus 2 commissions. The reward on this spread would be $1120 less $500 or about $650. Pretty thin at just slightly better than 1:1 but again we are only going to risk half or we are going to exit if July Sugar trades above 800. So probably the risk is only $100-$150. Again, I think a contract is the play here.

APRIL LIVE CATTLE

We commented on this market 2 weeks ago and we did do the 78/73 put spread. In fact, some of my clients did the 79/74. Most did the futures. We closed out the PUT spreads on Thursday early on and in most cases banked profits at least doubling our invested capital. The futures trades were also exited then making around $800 at minimum.

My “ACTION NUMBERS” now are a sell as close to 77.20 as they give me, the stop is 77.20. My initial target is Erich’s 7338 but I will be very watchful at the support about 75.20. Consider buying the April 76 put and selling the April 71 put for a debit of about 130 or $520. The maximum reward is $1480. I would risk no more than one half the $520 and would exit earlier if Cattle traded above 77.20.

I was asked the following question. “When I have sold an option as part of a Vertical Spread, how do I get rid of it when I take profits on the option I bought?”

You must grasp and understand the concept of “offsetting” if you are to ever make any sense of commodities trading. When you buy or sell a futures contract you do exactly the opposite to close the trade. For example, let’s say we bought a July Corn contract and July corn either went to our stop loss or it went to our profit objective. Either way we’d want to enter an order to sell July Corn wouldn’t we? Do we sell the EXACT contract, the SAME contract we bought? NO! We sell another July Corn contract … a different one than the one we bought.

We OFFSET the original buy of a July Corn Contract with a sell of another July Corn Contract.

It’s like an algebraic equation … a plus 1 (the buy), plus a minus 1 (the sell) equals 0 (we are now flat) [(+1) + (-1)] = 0. There is no ID number on the one contract we bought, we don’t have to search out the guy who sold it to us, we simply enter an order to sell one contract of July Corn to get out. The Exchange Clearing House handles all the accounting, it sees we bought one July Corn contract and that we have now sold one July Corn contract … ah … account number 12345 has a buy and a sell, he’s flat!!.

So it is with options. If we buy or sell an option to get put we simply do the opposite of what we did to initiate the trade to exit. By example, let’s say we bought a September Corn 240 call and sold a September Corn 270 call establishing a vertical Bull Call Spread. Corn goes to 234 ¾ … our predetermined exit point for risk management … and we want to exit the trade.

We would enter the following order … sell 1 September Corn 240 Call, buy 1 September Corn 270 Call … EXACTLY the opposite of the order we placed to get IN the trade. We would now have a +1 (the buy of the Sept Corn 240 Call) and a -1 (the sell of ANOTHER, completely separate and different Sept Corn 240 Call) … we are out, flat the September 240 Corn Call.

We would have a -1(the sell of the original September 270 Corn Call) and we would have a +1 (the buy of another, different September Corn 270 Call) … in both cases a PLUS 1 plus a MINUS 1 equals 0 … we are out, flat, done.

You must understand completely the concept of “OFFSETTING”. It is a key concept to how our markets function and explains much of the mystery of how we can buy or sell anything that is traded in the world of commodities.

I’ll be back next week,

Tom

R. Thomas Loge', CTA
1.800.656.0443 Voice
1.805.388.9863 Fax

Could you take me through a typical trade as far as when you look at the charts what are you looking for and how do you tie everything together?

There's nothing quite like following along in an analysis of a trade to get a feel for what's going on which is why we introduced the Pick of the Letter segment to the ezine. However your question had to do with the break down of analyzing a trade so here you go:

• Check to make sure there is enough life left in the chart you are analyzing. Ideally you want a minimum of two weeks before FND/LTD, but even this is cutting it a little thin. If I am in a market two weeks before the contract expires, I'm usually thinking about getting out, or rolling over into a further out contract. Three or four weeks until expiration would be more comfortable.

• Once you've settled on a market to analyze, calculate your retracement levels. I normally use the most predominant trend on the chart for my retracement calculations; however, this is not always the same as using the contract highs/lows. If there are two or three major trends on the chart, I would calculate the retracements for all three but would use the most recent as my first target (if appropriate).

Many times you will see that the market has already been reacting to the retracement levels. This is a good sign, as what the market has done in the past might give us a clue to what will happen in the future.

• Next consider if the current market position is making a formation which we can trade from, such as a channel or pennant. If it is, then your trade is pretty straightforward.

• Next determine the trend of the market on the daily and weekly charts. You will also need to consider the current market position in relation to the trend, retracement levels and nearby resistance. Always try to trade with trend if possible.

• Check your secondary indicators to see if the market is overbought/oversold. Also check the indicators to determine the strength of the trend and the likelihood that it will continue (ie. divergence).

• Now based on where you think the market could go (nearby resistance) and where it is, figure your profit/loss ratio.

We know that in an ideal situation we want a 3:1 ratio, and if you are trading with a small account, you should be patient and search out these opportunities. You might only be able to place a trade once every week or two, but the odds will be in your favour when you do.

Sometimes, when we know what our profit potential is, we can get a clue where we need to place our stops in order to get a 3:1 ratio. Sometimes this strategy will leave the stops within the market's daily range, making it more risky; but it might also make you aware of resistance that you had noticed which you could place stops behind.

However be careful not to read things into your charts that aren't there, in the hopes of being able to make a trade. Trading is a ruthless game. Be objective and remember to look out for yourself!

• Plan your trade. The profit/loss calculations will likely only be profitable in one direction, either long or short. You need to plan your trade so that it is profitable, whether or not the order is ever engaged.

If the market does not behave as you want it to, go look elsewhere. If it does behave as you’ve predicted, then you look like a genius, and you’re making money to boot.

• After you've done this with all the markets you are interested in, pick your best trade (if there is one) and call your broker.

For more information on how to trade a small account, be sure to follow along with the Pick of the Letter each week as I break down a market into specifics for you to learn from.

Erich

February is normally a strong month for Live Cattle contracts and as such we usually see prices peak at this time of the year. End of February, early March is also a time for calving and as such we see ranchers placing more livestock as they need to make room for the new additions to their herds.

Conversely while Lean Hogs are also breeding at this time of the year, more animals are kept for breeding purposes thereby limiting the amount available for slaughter. March Hog and Pig reports tend to show that spring has the lowest animal populations for the year. Hog slaughter declines into May and June, just when cattle slaughter is peaking. Strong demand in March for pork in cold storage has made this a particularly reliable spread.

Based on the above we are recommending buying June CME Lean Hogs (LEM3) and selling June CME Live Cattle (LCM3) on or about February 26th. Hold the spread until on or about March 25th. Profit target for the spread is $600.

If you have any questions about the spread or would like to know more about spreading markets, please feel free to call me at your convenience.