[Chart(s) Of The Week] The Importance Of Confirmation

Below is a daily chart of Cotton Futures, which broke out above long-term resistance last August but quickly confirmed a failed breakout by closing back below its 2016 highs. At the time, we accepted the failed breakout and got out of any long positions we had with the expectation that prices would work through that overhead supply and then break out.

Click on chart to enlarge view.

Turns out there was a lot more overhead supply at that level than we thought...and prices have fallen roughly 20% over the last year. Had we not respected our risk management levels and sat on the sidelines waiting for "confirmation", then we'd be stuck with a massive loser. Instead, we took a small loss and lived to fight another day.

The same need for confirmation can be applied to supplemental indicators like the Relative Strength Index. Idea Cellular Ltd. has been an absolute disaster and over the last 18 months has offered various signs of bottoming, namely a bullish momentum divergence. In other words, prices were making lower lows but selling pressure was waning. Something we often see occur ahead of counter-trend moves.

In the cases where we look to take advantage of a counter-trend move, we define our risk on the long side against the first low. As long as prices are above that first low, then the bullish momentum divergence remains intact and some mean reversion to the upside may occur.

With that said, all four of the attempts since May 2018 had failed to see much upside follow-through after prices confirmed the divergence. As a result, we took our small loss and moved on. Had we been stubborn and stayed long it since that first bullish divergence, we'd be sitting with a loss greater than 80% rather than a small paper cut.

At the end of the day, price is the arbiter of truth. Without it's confirmation, market participants tend to get themselves into a lot of trouble...as our two simple examples exhibit clearly.

Everyone has a different version of what "confirmation" looks like for their process, objectives, timeframe, etc. The point is not to tell you what type of confirmation you need, but to remind you that the next time you find yourself making a move in the market you should ask yourself if you have the confirmation your process requires...whatever that may look like.

Thanks for reading and let us know if you have any questions!

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Allstarcharts Team