I’m going to let you in on another one of my trading secrets, right here in this issue of Commodities Trends.

Today we’re going to discuss the cocoa market. I concede that neither you nor I will ever know as much about cocoa as the people at Hershey or Nestle. However, the big players in this market do leave what I call “footprints in the sand.” In other words, the smart money leaves clues as to what it's doing in the marketplace; you just need to know what to look for.

This brings us to the trading secret, which is simply this: Volume precedes price. I’ve found this to be valuable information for a commodity trader. What we’re looking for is a volume spike. A volume spike looks like a redwood among saplings on the daily chart. I define it as a day where the volume is at least twice the 30-day volume average. The chart below provides an illustration.

March 2003 Cocoa



Source: Commodity.com

In 2002, the cocoa market bottomed on June 11. On that day (and also the preceding day), volume spiked to more than two times the average daily volume for cocoa that year. This was the footprint in the sand, the clue to a major bottom in this market. A major change in ownership took place--from weak hands to strong hands--during the volume-spike day. Once the market broke above the high of the volume-spike day--in this case, 1,480--it took off. This particular move didn’t end until it reached 2,400 in October of that year. This was a move of more than $9,000 per contract on a margin deposit of only $1,200.

Need additional proof? Let’s look at the March 2006 contract.

March 2006 Cocoa



Source: Commodity.com

There was a volume spike on Nov. 11, 2005. Once the market broke out and closed above that day’s high of 1,365, the market took off, reaching 1,600 for a profit of more than double the margin deposit in just a few months.

Volume spikes don’t always come at bottoms. Sometimes they happen in the middle of moves, but they’re generally significant. Take a look at the December 2004 contract.

December 2004 Cocoa



Source: Commodity.com

Notice the definite volume spike on November 4; the market then opened above that day’s high the very next day. Volume surged for two more days, with the market moving up more than $2,000 per contract in just two days. It subsequently fell just as fast, but this was certainly a tradable opportunity. And once again, volume preceded price.

This brings me to a potential opportunity setting up in the cocoa market right now. Take a look at the March 2007 contract (as of October 27).

March 2007 Cocoa



Source: Commodity.com

Note the October 26 volume spike. The next step is to note that day’s high of 1,519. If the market trades and closes above this number, it would meet our criteria for a potentially dramatic purchase opportunity.

Cocoa futures prices are quoted in dollars per metric ton ($/MT). For example, “1,500” represents $1,500/MT--every $1 move in cocoa represents a $10 profit or loss per contract traded. In this particular case, should a buy signal develop, the suggested risk point would be just under the October 26 low, or in this case, 1,493.

The upside potential? Who knows; rather than pre-set a price, let the market make its move and follow it by raising your stop until the market eventually takes you out.

This trade secret works equally well in a variety of commodities and stocks, but it seems to work particularly nicely in the more thinly traded markets where the smart money can’t as easily cover up its footprints in the sands.

Good luck and good trading.

George Kleinman is editor of Commodities Trends.

© 2006 George Kleinman
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Risk Disclaimer

Futures and futures options can entail a high degree of risk and are not appropriate for all investors. Commodities Trends is strictly the opinion of its writer. Use it as a valuable tool, not the "Holy Grail." Any actions taken by readers are for their own account and risk. Information is obtained from sources believed reliable, but is in no way guaranteed. The author may have positions in the markets mentioned including at times positions contrary to the advice quoted herein. Opinions, market data and recommendations are subject to change at any time. Past Results Are Not Necessarily Indicative of Future Results.

Hypothetical Performance

Hypothetical performance results have many inherent limitations, some of which are described below. No representation is being made that any account will or is likely to achieve profits or losses similar to those shown. In fact, there are frequently sharp differences between hypothetical performance results and the actual results subsequently achieved by any particular trading program. One of the limitations of hypothetical performance results is that they are generally prepared with the benefit of hindsight. In addition, hypothetical trading does not involve financial risk, and no hypothetical trading record can completely account for the impact of financial risk in actual trading. For example, the ability to withstand losses or to adhere to a particular trading program in spite of trading losses are material points which can also adversely affect actual trading results. There are numerous other factors related to the markets in general or to the implementation of any specific trading program which cannot be fully accounted for in the preparation of hypothetical performance results and all of which can adversely affect actual trading results.