Sharp Cotton Fall-Out Stems From Mo Failure, Gross Bullish Exposure

January 31, 2018 8:06AM CST

The 240-min chart below details the past week's sharp decline with yesterday's continued losses leaving yesterday's 78.93 high in its wake as the latest smaller-degree corrective high this market is now required to sustain losses below to maintain a more immediate bearish count. For longer-term reasons we'll discuss below, this admittedly smaller-degree corrective high serves as a tight but important risk parameter around which to more objectively negotiate what's likely to be continued volatile price action and a larger-degree peak/reversal-threat environment. In lieu of such 78.93+ strength at least the intermediate-term trend is down and should not surprise by its continuance.
Cotton_Mar18_240min_Chart
cotton_mar18_daily_chart
In Mon's Technical Blog we emphasized the importance of the combination of that day's confirmed bearish divergence in momentum below 81.43 on a daily close-only basis above with historically frothy levels in our RJO Bullish Sentiment Index of the hot Managed Money positions reportable to the CFTC that left the market vulnerable to potentially sharp losses, especially given the extent and uninterrupted nature of Oct-Jan's meteoric rally. Indeed, at a current 93% reading reflecting a whopping 117K Managed Money long positions to just 9K shorts, the market was vulnerable to the type of sharp losses seen the past week as the overall market likely forced the capitulation of at least some of this extensively skewed bullish exposure.

While it's crystal clear that Oct-Jan's uptrend has been broken, establishing 19-Jan's 83.42 high close and 22-Jan's 83.95 intra-day high as obviously important highs and risk parameters from which non-bullish decisions like long-covers can be objectively based and managed, the new technical and trading challenge is one determining whether the recent swoon is just the start of a broader peak/reversal environment OR just a correction within the the uptrend from last Jul's 65.94 low. Indeed, thus far this relapse has only retraced a Fibonacci minimum 38.2% of Oct-Jan's 66.77 - 83.42 as shown in the daily chart above. Given the magnitude of Oct-Jan's rally, this "minimum" Fib retrace cannot be ignored as a (4th-Wave) correction ahead of a resumption of the multi-quarter bull.

It is for this reason exactly why we have three reversal requirements:

  1. a confirmed bearish divergence in momentum (SATISFIED)
  2. proof of impulsive, 5-wave behavior in the direction of the prospective new trend (SATISFIED) and, most importantly,
  3. proof of 3-wave, corrective behavior on a subsequent recovery attempt (NOT SATISFIED).

It simply stands to reason that IF the recent decline is the start of "something broader" to the downside, that subsequent recovery attempts unfold in a labored, corrective manner. Once satisfied, the market will have provided all the evidence we need to objectively position for a new bear and, most importantly, identified TWO specific highs from which the risk of that new bearish policy can be objectively based and managed.

Waiting for this third reversal requirement begs the question: What if we don't get that recovery and the market just collapses from here?

This is a great question because it's not like it's never happened before. And the answer/considerations are these:

  • first, by protecting previously recommended bullish exposure with bull risk parameters below 81.43 and/or 77.50, the risk/cost/bleeding of those longs has been truncated; if the bear continues, no more harm can be inflicted.
  • typically, peak/reversal environments include corrective (2nd-wave or right-shoulder) retests of the high within a broader peak/reversal PROCESS that takes TIME and sometimes "extended" price rebuttals in order for the previous bullish fundamental and technical factors to erode.
    • markets typically don't go from rip-roaring bull trends immediately to collapsing bear trends as it takes time for those factors that were soooooo bullish to erode and reverse
  • Given the extent of the recent collapse as well as the likelihood for a corrective rebound, we typically don't recommend "chasing" initial counter-trend moves, but rather to wait for the corrective rebuttal for a preferred risk/reward condition to enter a new bearish policy.
  • those fearing a continued collapse and thus have a desire or requirement to establish bearish exposure "down here" have two choices with respect to the RISK associated with this choice:
    • define this decision as a LONG-term one in which the risk of that short is incurred to 19-Jan's 83,42 high OR
    • define this decisions as a SHORT-term one and find the tightest but objective risk parameter around which to do so. Currently, we believe this level is yesterday's 78.93 smaller-degree corrective high discussed above.

cotton_mar18_weekly_chart
Finally, the monthly log scale chart below shows the market's recent ascent to the upper-quarter of the 6-YEAR range that we discussed as a slippery slope. As a result of the past week's relapse this market is arguably simply repeating the technical condition and exercise it went through last Mar-Apr-May'17. We've also discussed the higher odds of aimless whipsaw risk stemming from a market's position in the middle-half of an established range. Such aimlessness and increased volatility aptly describes exactly what this market has thrown at us since Jul 2016. And as a result of the combination of this week's bearish divergence in momentum and frothy bullish sentiment, we believe that the directional scales have turned down for the foreseeable future and that recovery attempts to approximately (for now) the 81.00-area OB be approached as corrective selling opportunities.

In sum, a neutral/sideline policy is advised for the time being as we believe the risk/reward merits of chasing bearish exposure "down here" are poor. For those wanting or needing to get some bearish exposure on, your personal risk profile will dictate whether a recovery above 78.93 or 83.95 is needed to negate this call. Preferably, we advise waiting for a suspected corrective rebound that could be extensive in terms of both price and time before establishing a new bearish policy. Strength above 83.95 is required to negate this call and reinstate the major uptrend.

cotton_monthly_chart

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