{"id":193578,"date":"2024-05-06T11:15:00","date_gmt":"2024-05-06T15:15:00","guid":{"rendered":"https:\/\/ibkrcampus.eu\/uncategorized\/cuckoo-for-cocoas-puff\/"},"modified":"2024-05-08T10:24:55","modified_gmt":"2024-05-08T10:24:55","slug":"cuckoo-for-cocoas-puff","status":"publish","type":"post","link":"https:\/\/www.interactivebrokers.eu\/campus\/traders-insight\/securities\/commodities\/cuckoo-for-cocoas-puff\/","title":{"rendered":"Cuckoo for Cocoa\u2019s Puff"},"content":{"rendered":"\n

The recent price movement in a key commodity \u2013 at least for chocoholics like me \u2013 illustrated some key tenets about trading highly volatile markets.  In recent weeks, cocoa prices have been cuckoo. We had a parabolic rise, extreme backwardation, and now a blowoff from the top.  It\u2019s simultaneously highly unusual yet all too familiar. <\/p>\n\n\n\n

Let me preface today\u2019s piece by establishing that I have no particular insight into the cocoa market.  It is a commodity with worldwide use but dominated by a relatively tight cadre of huge consumers and regional producers, and I\u2019ve never interacted directly with any of them.  But I do have quite a bit of experience in trading and analyzing extraordinary market moves.  And cocoa\u2019s recent runup and even more recent plunge fit a broadly similar pattern. <\/p>\n\n\n\n

Below is a chart showing cocoa futures\u2019 recent moves:<\/p>\n\n\n\n

Rolling Front Month NYBOT Cocoa Futures, 6-Month Daily Candles<\/em><\/strong><\/h3>\n\n\n\n
\"Rolling<\/figure>\n\n\n\n

Source: Interactive Brokers<\/em><\/p>\n\n\n\n

Past performance is not indicative of future results<\/p>\n\n\n\n

The obvious takeaway is that the price of cocoa roughly tripled between the start of the year and mid-April.   But as with many stellar moves, this one began slowly and rather inauspiciously.  The price meandered in the $3500-$4000 range for months before bottoming with a bit of a volume spike in early January.  The price appreciation from that point on was solid, and while it seems relatively unspectacular compared to what transpired later, the commodity rose over 30% with a bit of a parabola into the huge volume spike that occurred in February.  From that point onward, it was relatively straight up for the commodity.  Financial media could hardly ignore the advance that followed, which undoubtedly brought in a wider range of speculators.  The overall volumes tended to dip even as the rapidity of the advance was increasing.  We then saw a bit of intense volatility in mid-April that eventually turned into the major price correction that we see now.<\/p>\n\n\n\n

There are three key truisms that we would like to highlight today:<\/p>\n\n\n\n

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  1. Parabolic moves: A frequent theme of ours is that \u201cparabolic charts mean someone is in pain<\/a>.\u201d  We wrote consecutive articles in March 2022, when various commodities were launching higher in an inflationary frenzy.  The latter shared the title linked above<\/a>, while the former elaborated on a recently taped podcast<\/a> discussion with Thomas Peterffy about trend following.  After relating some of the podcast\u2019s key points, we elaborated<\/a>:<\/li>\n<\/ol>\n\n\n\n

    Commodities charts have become downright scary.  Most of them are in backwardation \u2013 implying a short-term scarcity in the underlying commodity \u2013 and some, like oil and wheat, have gone parabolic in recent sessions.  Parabolic uptrends are almost always unsustainable for long periods of time and tend to reverse abruptly and sharply.  The question is when.  Parabolic uptrends imply that some group is desperate for the commodity or security in question.  In the case of stocks, that tends to resolve itself naturally.  In the case of necessities, like the commodities having the most extreme moves, supply\/demand can take longer to equilibrate.  Can they reverse tomorrow?  Sure.  When will they actually reverse?  Ummm\u2026.<\/em><\/p>\n\n\n\n

    In a bout of prescient timing, the nickel market imploded in between when the first and second pieces were published.<\/p>\n\n\n\n

    The takeaway here is that while it can be incredibly tempting to chase a parabolic move, you are ultimately trying to exploit someone else\u2019s agony.  This is not a moral statement, but instead is meant to illustrate why trading parabolic moves can be so dangerous.  At some point, the original impetus for the panicky move abates.  That leaves a group of speculators trading against each other, many of whom have no particular expertise in the commodity in question.  And that is when the reversal begins, albeit unpredictably.<\/p>\n\n\n\n