Newsom on the Market Retreat

Retreat: To move back or withdraw; or a quiet, secluded place where one can rest and relax. (DTN photo by Darin Newsom)

Retreat. As a verb, it's a word you don't want to hear from behind you in battle. As a noun, it can also mean to move back or withdraw; but also a quiet, secluded place where one can rest and relax. As for the latter, people need that once in a while, and so do the markets, particularly after the recent rise in volatility.

We know what we look for in a retreat: a secluded cabin in the woods, a quiet hut on the water, a trip to the big city during down season. (With that in mind, don't forget to register for this year's DTN/The Progressive Farmer Ag Summit in December. Chicago is always lovely that time of year.)

But what about markets? How does a collective system of millions of different opinions regarding price take a breather? It's called "retracements," and something we not only see, but anticipate in every market trend.

So, what is a retracement? Think of it as a combination of the two noun definitions above. It's a time period when a market moves back against its trend, usually taking the heat off of boil for a short time. How far a market moves back has a lot to do with its real fundamentals, those indicated by its futures spreads, allowing us as analysts to establish possible price targets. 

Those of you familiar with my analysis know I have developed a method of analyzing trends (price direction over time) based on the simplest application of Elliott Wave Theory. Recall from previous discussions that a complete 8-wave cycle consists of a 5-wave uptrend and 3-wave downtrend. In an uptrend; waves 1, 3, and 5 are up with the third wave being the strongest. Waves 2 and 4 or down. In a downtrend waves are given letters to differentiate with A and C being down, B being up. 

These retreating waves (2, 4, and B) are often read as major changes in price direction, but are nothing more than retracements. Go back to my Technically Speaking blog from July 1 and look at "Monthly Grain Analysis." There you'll see a long-term monthly chart of one of my favorite markets (from a technical point of view), the DTN National Corn Index (NCI.X, national average cash price). Note that Wave 1 (first faint green arrow staring in October 2014) peaked in late December 2014, leading to the market retreating (Wave 2, first red arrow) through early June. Notice that Wave 2 bottomed out at $3.29, near (enough for me) its expected target of $3.31, a price that marked the 50% retracement level of the Wave 1 range from $2.81 to $3.80. 

Again, those of you following along with my analysis over the last year (at least) will recognize the significance of the 50% retracement level. If a market has bearish real fundamentals, its futures spreads showing a strong carry (contango in the world of energies and metals), then we would expect a retracement (particularly during Wave 2) of at least 67% to near 100%. If a market's real fundamentals (spreads) are only neutral to bearish, the expected retracement range would be 50% to about 67%. Neutral to bullish real fundamentals tend to result in retracements of 33% to 50%, while bullish real fundamentals generate retracements of 33% or less.