Lumber futures took a dive yesterday, right after they hit a new all-time high. The much sought-after commodity lost almost 4% of value, ending an uninterrupted 14-day run higher.
Still, the agricultural commodity is so hot that prior to the recent run-up, the contract rose for 15 days in a row. Characterizing this ongoing rally as staggering would actually be an understatement. From the start of 2021 until yesterday's record, the price nearly doubled, adding 92.7% this year.
The cost of homebuilding materials have quadrupled in the past year due to a surge in new home construction and renovation as the real estate sector ignited, fueled by pandemic conditions that drove many people to look for larger homes away from crowded cities. As well, lockdowns and work-from-home mandates convinced many to remodel.
The result, materials inventories across the country have been depleted with builders racing to find wood products, bidding up prices into peak spring and summer building season. Reports say mills are restarting to add to the supply, but for now demand remains strong.
Indeed, the faster and more acute an advance, the stronger the potential for a powerful decline amid profit-taking. And yesterday’s trading completed a bearish pattern.
Lumber completed a powerful Evening Star—a three-day candle formation that preducts a downward reversal. A variety of factors increase the significance of the pattern on the lumber chart:
- The middle candle—the star—is separated by gaps from the preceding and following candles.
- The third candle closed deeply into the preceding rise, erasing more than three days worth of gains. The minimum requirement to consider it a proper Evening Star is for the last candle to close halfway into the pattern’s first candle. In this case bears went above and beyond, cutting into the middle of the second candle beyond those of the pattern.
- Given that the dynamics of the reversal pattern are fueled by the preceding rally—the greater the advance, the larger the profit-taking to follow—the current reversal occurred after the longest rally on record into an all-time high.
- After the RSI topped 91, possibly the highest level for this contract on record, it fell to the previous low, demonstrating that momentum has fallen to the level the price reached on Apr. 20.
- The ROC, another, more sensitive momentum gauge, threatens to complete a H&S top.
Trading Strategies – Contrarian Short Position
Conservative traders should avoid this trade as it goes against the still ongoing uptrend.
Moderate traders would wait for the price to retest the record before jumping in.
Aggressive traders could short at will, provided they accept the risk of the price retesting the pattern top, and either include the range in the stop-loss—which would increase their exposure—or commit as much as they’re willing to, while accepting that they could be stopped out. Money management is key.
Here’s an example of a basic trade plan:
Trade Sample
- Entry: $1,641
- Stop-Loss: $1,691
- Risk: $50
- Target: $1,491
- Reward: $150
- Risk:Reward Ratio: 1:3
Author's Note: We are not claiming to know the future. This is our interpretation based on technical analysis, which considers the evidence and projects a statistical course. That means it won't work every time, nor can one can know in advance whether it will or won't in this particular instance.
This is one of a number of different ways to approach this trade. You must learn to customize a plan to your timing, budget and temperament. Until you know how to do that, you may use our samples in order to learn, not for profit. If you don't understand what you're doing you will end up with neither.