Futures For You
INSIDE THE FUTURES WORLD
Want to find out how the futures markets really work? Carley Garner, a senior analyst for Alaron who also writes the company's Dow/NASDAQ Report and the Bond Report newsletters, responds to your questions about today's futures markets. To submit a question, post your question at http://Message-Boards.Traders.com. Answers will be posted there, and selected questions will appear in a future issue of S&C.
How can we take advantage of seasonal tendencies?
It is no secret that true commodities such as the grains and energies have distinct seasonal patterns. These seasonal tendencies are often the result of annual harvest cycles or product demand cycles. Accordingly, you may have heard the term "harvest lows" used in reference to markets such as soybeans or corn. Likewise, the media refers to the summer driving season as a catalyst for energy prices.
Beginning traders often assume that making money is as easy as buying unleaded futures at the end of May. Yet it is important to realize that the markets (in the long run) are efficient.
For example, the seasonal price fluctuation relating to the increased traffic on the road during the summer months actually occurs in the spring, and timing the move isn't as obvious as we would think. Similarly, heating oil futures rally well before the winter weather ever becomes a reality. Hence, don't presume that buying a heating oil call in September is a sure thing. Too many beginning traders allow themselves to buy into media hype without fully understanding the big picture of seasonality, the markets and, most important, the challenges of profiting from them.
Similar to the way that fear and greed dictate futures market speculators, these emotions play a large part in the cash value of a commodity. The price of grown commodities undergoes cycles of peaks and valleys based on recurring events. This cycle is often referred to in terms of "risk premium." Simply, risk premium is the product of fear of shortage on the consumer end and monetary motivation for producers to withhold supply from the marketplace. Field crops, energies, and the softs often succumb to phases in which risk premium is built into market pricing, then subsequently removed.
For example, in the case of grown commodities, until the seeds are in the ground there is no telling how much of the available farmland will be dedicated to corn, soybeans, cotton, and so forth, leaving the next crop yield (supply) uncertain. Farmers will opt to grow crops that they consider to be more profitable. As a result, consumers begin to bid prices higher out of fear of a shortage. Consumers also know it isn't necessarily important what farmers claim that they will plant but rather what they actually put in the ground that counts, and the market knows that. Therefore, the risk premium typically remains until the seeds are actually in the ground. If you are interested in researching this topic, I recommend Commodity Trader's Almanac, written by Scott Barrie.
The market's tendency to build and remove risk premium is the basis of grain market seasonality. However, expecting seasonality to be your holy grail may result in financial peril. Using seasonal tendencies as a guide rather than a rule may be best.
ENTRIES AND EXITS
A lot of newsletters recommend seasonal trades along with entry and exit dates. Should I be following these?
I cannot speak specifically in regards to all seasonal newsletters and services, but similar to all other aspects in trading, there are no guarantees of profit. All recommendations should be researched and confirmed accordingly. Many seasonal services will provide entry and exit dates along with the rate of success over a certain time period, usually 15 years. They may also give you the average gain or loss for the trade over the same time period. However, what you may not be able to see is the drawdown that the trade suffered between the entry and the exit. Simply put, the entry and exit dates provide a snapshot of the recommended position and how it has averaged based on those exact two instances in the past. On the other hand, what happens in between these points is unknown and could be significant.
Specific seasonal recommendations in the format mentioned shouldn't be avoided altogether but approached with caution. Simple risk management strategies such as placing stops or using protective option spread plays may be a wiser approach. Additional fundamental and technical analysis should also be conducted to verify your agreement with the recommendation.
HOW ABOUT THOSE FINANCIALS?
Seasonal tendencies make sense in a raw commodity, but can they be helpful in the financials as well?
Believe it or not, the financial markets such as Treasuries, currencies, and stock indexes appear to have distinct seasonal patterns. The causes of the annual tendencies of these markets aren't as clear as those in raw commodities, but they do exist and that is all you need to know. Remember, traders should be looking to profit from the markets, not write a thesis.
To illustrate, equities tend to perform better from the beginning of November through mid- to late May. I am sure you have been introduced to the adage, "Sell in May and go away." Similarly, the Treasury market has a strong inclination to rally in the beginning of June; perhaps the early summer rally in the interest rate complex has something to do with portfolio adjustments away from stocks. In any case, it is to your benefit to be aware of the propensities of the market to improve the odds of successful trading.
As an avid follower of the stock index futures, I believe in having access to historical market data and source of seasonal tendencies. The best example I can think of in this regard is the Stock Trader's Almanac. I would never recommend initiating a trade based on seasonals alone, but as a rule of thumb, I wouldn't necessarily recommend trading against it either -- unless, of course, there is a great opportunity.
Originally published in the July 2008 issue of Technical Analysis of STOCKS & COMMODITIES magazine. All rights reserved. © Copyright 2008, Technical Analysis, Inc.
Return to July 2008 Contents