Trading opportunity: Wheat forms bullish potential chart pattern

Since making a multi-year high of $9.47-1/4 a bushel on 23 July, wheat has entered a tight trading pattern known as a “bull flag” which could signal that the commodity will soon move higher.

The technical’s

The bull flag chart pattern is so-called because it resembles a flag flapping in the wind at the top of a flagpole.

Valid bull flag patterns are typically preceded by a sharp advance (or decline) on heavy volume, and mark a pause or period of consolidation before the prior move resumes. The flagpole is the measured as the distance from the first resistance (or support) break, to the high (or low) of the flag formation. The flag itself should slope against the direction of the previous trend and be contained within two parallel trend lines.

A 9 month chart of wheat (Click on the chart for a larger version)

A 9 month chart of wheat (Click on the chart for a larger version)

Chart courtesy of stockcharts.com

In order for the above pattern to be validated, we would need to see wheat breakout through the upper blue trend line in decisive fashion, preferably on strong volume, and a breach of the lower trend line (circled) would invalidate the pattern.

The target for a positive breakout is calculated by adding the length of the flagpole to the breakout level witnessed.

One problem with the pattern in wheat is that it is getting rather long in the tooth. Flag patterns tend to be short-term patterns that last from 1 to around 12 weeks, though this still the subject of debate. According to some, once a flag becomes older than 12 weeks it is classified as a rectangle pattern, however these are still considered to be continuation patterns.

The fundamentals

In terms of the fundamental outlook for wheat, various factors still point to higher prices. The severe drought that has plagued most of the US, parts of Mexico, and central and Eastern Canada since the beginning of spring is still a major problem.

The weekly US Drought Monitor report released Thursday shows that more than 62% of the contiguous United States remains in some form of drought as of Tuesday. One fifth of the lower 48 states still is in extreme or exceptional drought — the two worst classifications.

A US Department of Agriculture (USDA) Crop Progress Report in November showed that 39% of the US winter wheat crop (around half of which is exported) in good or excellent condition, the lowest rating for this time of year in 27 years.

The US Drought Monitor’s latest drought map (Click on the chart for a larger version)

The US Drought Monitor’s latest drought map (Click on the chart for a larger version)

Map courtesy of droughtmonitor.unl.edu

Elsewhere, Argentina’s wheat crop has been impacted by a combination of heavy rain on the coast and a severe drought in inland areas.

It has also been estimated that wheat production in Australia, the world’s second largest exporter, will probably decline by 28% to the lowest level in five years, again thanks to dry weather.

South Africa is also likely to reap a wheat crop that is around 12% smaller than last year.

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