29 June 2007

Charting Support & Resistance on Futures... Hmmmmm

Charting support and resistance on commodity futures charts can be a bit tricky. The futures price will be the cash price of the commodity plus carrying costs, so deferred contracts can be higher priced than the nearest contract as the physical commodity may have to be held in storage longer. This is referred to as contango.

However, some factors may make the deferred contracts price less than the nearer contracts. This may be lack of immediate demand for deferred delivery, new crop verses old crop supply, as a couple of quick examples.

This has ramifications when looking at charts over the longer term. When looking at a chart of a single contract where cost of carry has been priced in that cost will naturally decay as time goes by, similar to, but nowhere near the extent, of an options contract. This also affects the continuous chart. When one contract expires the next contract is simply tacked on to the continuous chart. The expiring contract's cost of carry will have decayed away to zero, while the new contract being added will have carrying costs reflecting the time till expiry.

Consider the two charts below. The first is The August 2007 contract and the second is the continuous contract.



Notice the difference between the two charts. The August contract shows the recent $70 resistance as have just been broken, yet the continuous shows resistance at a lower level. It also shows some other differences shown by the lower red line in each chart.

This is a profound difference for those used to charting share prices where such factor do not exist.

My approach is to chart short term support and resistance on the individual contract, but to chart long term support and resistance on the continuous chart. Where is the dividing line? That's a tough one; over the time frame of the above two charts is a grey area which I don't have an answer for.

In the end it depends how you trade and what your view of technical analysis. I'm more of a swing trader so the long term charts are more of an academic interest and do analysis on individual contracts, but that's just my way.

Something to be aware of for chartists.

4 comments:

grant said...

Ahhhh, the visual verification thingy is now gone, so I can come and visit.

Time, with it's associated costs always add another wrinkle to the analysis.

However, unless the carrying costs are a significant % of your risk/return, which then may negate your trade, they are generally not a trade breaker as they are fairly consistent and can be calculated [allowed] for.

jog on
grant

w.a.l. said...

Yes true, cost of carry is not a consideration in risk/reward calcs, well negligible anyway.

It more the point that horizontal support and resistance can be regarded with a bit of initial suspicion when using them to base entries/exits on.

This phenominon(?) even catches BubbleVision out when reporting on commodities prices. When one spot contract rolls to the next, BubbleVision will report the price increase when all that has happened is the that there is difference in price due to the contango.

We shouldn't be surprised by that though. :)

grant said...

wal,

Bubblevision should carry a govermental wealth warning, but like most things that you shouldn't do, you watch regardless.

How do you account for weather risk etc in the softs, coffee, corn, wheat etc. in a chart?

Or would you undertake additional analysis to complement a chart based analysis.

Commodity fundamentals if you will.

SBUX for example is struggling currently with costs based on an unhedged exposure to milk.

Corn & ethanol spring to mind.

jog on
grant

w.a.l. said...

"How do you account for weather risk etc in the softs, coffee, corn, wheat etc. in a chart?"

You can't. While not pretending to understand all the fundamentals, I do try to follow whats happening fundamentally via news and commodities specific message boards. One can often get early warning of weather details etc as many growers post the conditions in their area.

That said. Announcements can gave similar effects as the stock market. Today is a prime example. Bullish news was released concerning soybean acreages and kapow! A huge gap up.

Nobody saw that coming. Cotton gapped up on news as well.

It's just part of trading anything really. Where the danger lies is when folks get carried away with trading on margin and over leverage themselves.