Should we buy the momentum breakout in coffee
Key points:
- Coffee futures rallied more than 10% in the trailing 5-day period
- The commodity also closed at a 105-day high, but it remains > 5% below a 252-day high
- After similar setups, one should be mindful of a potential bull trap
Should we buy the momentum breakout in coffee
Coffee is surging, and the chart pattern looks bullish. If I put my technical analysis hat on, I would describe the setup as a bullish continuation pattern. However, the team at SentimenTrader avoids subjective analysis and lets the data do the talking.
Let's use history as a guide to see if we should buy the momentum breakout in coffee. I will identify when the 5-day rate of change for coffee increases by 10% or more and the commodity simultaneously closes at a 105-day high, which is the case now. I will also require coffee to be more than 5% from a 252-day high, a condition similar to now.
Similar signals preceded negative returns
Buying a momentum breakout in coffee under conditions similar to now looks unfavorable across most short and medium-term time frames. If the commodity deviates from history, the next couple of weeks should provide us with a clue. Strong momentum in the first two weeks for signals in 1975, 1979, and 2014 led to more upside.
Coffee looks overbought on a long-term basis
The 2-year rolling return exceeded 150% for only the 4th time in almost 50 years. Previous multi-year surges suggest the commodity is closer to the end of an uptrend versus the beginning of one.
Mean reversion is the norm for commodities
Coffee, like most commodities, rarely sustains an uptrend for a meaningful amount of time. Applying my composite trend model to coffee shows a positive trend score 45% of the time since 1973.
What the research tells us...
Coffee is surging, and the chart setup looks compelling. However, as the study shows, momentum breakouts with similar conditions to today tend to fail. While this time could be different, I would be mindful of a potential bull trap.