Coffee has been under heavy pressure over the last 25 trading periods.
During this time, price has dropped 20 cents or 14%. When measuring all declines over a 25 trading day interval going back to 2006, 2,974 trading days, this places in the 88th percentile. While not a reversal signal in and of itself, it shows us that this decline is approaching a statistical extreme.
There are numerous signals that a reversal is at hand - Lets take a look at the setup.
1) Extreme in Trader Positioning
In looking at this week's COT report we see Commercial and Fund positions at opposite extremes.
We rank participant positioning and activity, and score this on a 18m + 5yr basis to highlight extremes. Just like price, positioning tends to revert back to the mean over time, so this reading is signaling a potential unwind. This week we see Coffee Commercial Trader 18m + 5yr Scores at 99%, while funds are at zero.
So even though we have witnessed a sharp 14% selloff, instead of seeing profit taking, we see the Trend Following funds remaining massively short.
In analyzing price movement in Coffee since 2006, we see that the Average Price movement over 20 Trading Day Interval is 10.6 cents up by 9 cents down. The 70th and 80th percentile movements are 4.45up by (3.85) down and 2.85up by (2.40) down respectively.
However, when Commercials net position 5yr Score is 95% or greater, as witnessed this week, we see the following price distribution. Average movement is now 10.84up by (5.09) down. 70th percentile is now 6.05up by (1.70)down, and 80th is 4.90up by (1.35)down.
So we see a significant statistical edge here. Average Bull Bear odds have moved from 10.6 to 9, to now 11 to 5 in Bulls favor.
The 70th + 80th percentile Bull:Bear odds have moved from 4.5 to 4, to now being 3-1! So there is a significant edge for Bulls given this current positioning.
2) Lets look at the Price action now:
A - After the sharp drop we started seeing candles that were flagging indecision, as opposed to continued downside strength - Spinning tops/ Dojis/Hammers. These candles show bears trying to continue pressing their advantage, but are being met with equal and offsetting buying.
B - Yesterday, we saw a clear break of the downtrend line on heavy volume.
C - Our proprietary oscillator has been flashing a non-confirmation to the bearish price action over the past 3 weeks - Signaling the price decline has lost momentum.
So at this point, all we need is some positive technical action to turn trends neutral or bullish, and we will then see Hedge Funds start to unwind their massive short position fueling at minimum a tradeable bounce.
Please look here:
Yesterday's price move saw our adaptive moving channels turning green on a 4 + 9 day basis, with the 23 day turning neutral. This is just the type of price action that commences a short covering rally.
Hedge Funds are massively short after a extreme price decline in Coffee, and now price action is starting to turn bullish.
Even if you are a coffee bear due to expected strong crops, a normal 50% retrace of this initial down leg offers 6-8 cents higher from here.
Our preferred tactics here are to sell the 122.5 March contract Puts for 2 cents - These options expire in 41days.
Or you can go long the March Future here at 1.30, buying an ATM put for approx 4.5 Cents. Once we get the expected 6 cents rally, you can then sell a call 5 cents out of the money for approc 2.5 cents, reducing the cost of insurance by over 50%. Our upside is therefor 8cents, with downside of 2 cents for a Risk/Reward setup of 4-1.