The decline in Coffee continues but a major reversal may be ahead

Having reached a multi-year high of $3.09 per pound in May 2011 the price of coffee has been in a steady decline. Over the past few months however, the price of coffee has begun to form a potentially bullish chart pattern that could signal that a major reversal lies ahead.

The Falling Wedge Reversal Pattern

The Falling Wedge pattern is a bullish chart pattern that begins wide at the top and narrows as the price declines. There are two types of falling wedge pattern, a continuation pattern which moves against the prevailing uptrend, and a reversal pattern which moves with the prevailing trend (as with coffee). In both cases the falling wedge slopes downward, and in both the pattern is regarded as bullish, however the bullish bias is not confirmed until the price breaks out through overhead resistance.

A 1 year (daily) chart of coffee (Click on the chart for a larger version)

A 1 year (daily) chart of coffee (Click on the chart for a larger version)

Chart courtesy of stockcharts.com

Coffee basics

Coffee plants take from three to five years to begin producing fruit, and the bean is actually the seed inside the red or purple fruit. Two types of bean make up 90% of the coffee cultivated worldwide: The Arabica and the Robusta, with Arabica delivering a higher quality product. Arabica beans are brewed by specialty companies including Starbucks Corp. (SBUX), while the Robusta beans are used by companies such as Nestle SA (NESN) for instant coffee.

How to profit from a possible reversal in coffee

The narrowing of the cone-shaped pattern indicates a decrease in downside momentum. If the pattern is confirmed as bullish, we should see the price breakout through the upper downtrend line, however it is important that this breakout is accompanied by a spike in trading volume.

The breakout may also be accompanied by a CMF (Chaikin Money Flow) reading that pushes into positive territory and a positive divergence on the MACD indicator.

Traders and investors looking to profit from the potential reversal in the price of coffee could wait for the breakout to occur, or even place buy orders above the upper downtrend line.

One possible trigger for a reversal in the price of coffee could be the ongoing drought in Vietnam. The nation is the biggest producer of the Robusta variety of coffee and dry conditions in the top producing region are expected to continue throughout March.

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