Overcoming Greed and Fear in Commodity Markets Larry Martin, Ph. D. Agrifood Management Excellence 519 841 1698, dlm@xplornet.com
Introduction Presentation based on our company s recent column in Country Guide Work with farm and agribusiness clients to manage price risk Issues in managing price risk include: Failing to sell at high prices and then taking low ones Panic selling at low prices and foregoing opportunity, including having large margin calls Just went through major rallies on grains and livestock should I sell here or wait for it to go higher?
Introduction Those are manifestations of fear and greed. Constantly have bull bag and bear bag it s what makes a market In red meat at the moment bearish supply numbers, bullish domestic demand, strong but uncertain export demand Similar in grain demand issues are at least as important as supply, are there any techniques that can help manage some of these issues in uncertain markets
Wrong Question Most frequent, but least relevant question is what do you think these (hog, corn, canola, C$, soy, corn...) prices are going to do?
Right Question, As prices change, where do I take action and what action should I take?
Objectives Define some methods of reading price charts that can help change the question from where do I think prices are headed? to where should I take action? Suggest and illustrate some trading rules for deciding when and what actions to take.
Market Conditions: The Bull Bag Positive carry for Dec corn and Wheat Drought affecting corn and soy in Argentina, South Africa, Paraguay Major hog expansion in China Strong domestic demand for red meat Low soil moisture in US southwest
Market Conditions: The Bear Bag Livestock heavy US supply, major expansion in Chinese hog production Lots of meat in inventory Grains large inventories, especially wheat, large Brazilian crop, good soil moisture in Russia, Ukraine, Canada Very large Malaysian palm crop India has substantial tariffs on edible oils Managed Money just moved to large net long positions for corn and soy, or substantially reduced net shorts for wheat Trump!
Trade Policy: The Uncertain Bag The wise leader of the US threatens to pull out of NAFTA, creating uncertainty in red meat The wise leader of the US pulled out of TPP, giving Canada a wonderful opportunity in an agreement that favours red meat (See New Yorker article, Making China Great Again!! The Guy with the Pretty Hair was wise enough to opt into CPTPP and, potentially, the Chinese equivalent Russia, Ukraine, Brazil are all investing heavily in transportation and port facilities. Canada, not so much.
Some Chart Concepts So, with all this uncertainty, where do we think prices are going (oops)!! Where should we take action and what action should we take? Six chart formations that help interpret price trends. First, historical volatility:
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2 Live Cattle Continuation, 1990 Last Friday LIV CAT APR8 (123.650, 124.825, 115.750, 116.050, -11.4500) 180 175 170 165 160 155 150 145 140 135 130 125 120 115 110 105 100 95 90 85 80 75 70 65 60 55 50 45
Corn Continuation, 1990 Last Friday CORN MAY8 (374.000, 390.750, 369.250, 377.250, +2.75000) 900 100.0% 850 800 750 700 61.8% 650 600 50.0% 550 38.2% 500 23.6% 450 400 350 0.0% 300 250 200 150 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2
Support and Resistance Resistance Flat line along tops Support Flat line along bottoms Life of contract high/low, double or multiple tops, Fibonacci retracements can be particularly significant
P SUPPOR DRAWN PAST LO P LIFT SHO HEDGES TOWARD PLANE P MOST SU LIFE-OF- CONTRA Stylized Resistance and Support at Contract Highs and Lows
Double Top! DOUBLE TOP ALONG MAJOR RESISTANCE PLANE! DOUBLE BOTTO ALONG MAJOR SUPPORT PLANE! RELIABLE FORMATIONS
March Spring Wheat Future Multiple Bottoms and Tops
Key Reversals Tops contract high, outside day, lower close Bottoms contract low, outside day, higher close
Key Reversal Top and Bottom
Fibonacci Retracements 62% 50% 38% P MARKET MOVES IN CYCLES P MARKET TENDS TO CORRECT THE PRECEDING MOVE IN PRICE P CORRECTIONS TEND TO BE 38%, 50% OR 62% P CORRECTION PROVIDE PRICE OBJECTIVES P FIRST OBJECTIVE IS 38% CORRECTION
March Spring Wheat, Multiple Tops and Bottoms, Fibonacci
Relative Strength Index Based on previous 14 days prices Measures the short term momentum of price trend As it s name implies, it s an index 0-100 50 means no trend 80 means strong upward trend 20 means strong downward trend We use divergence of RSI and bar chart as indicator of change in trend
Relative Strength Index with Failure Swing RSI 70 30! PRICE DIVER SUGG REVE! RSI GI WARN! RSI AL PROD OPPO! KEEP
RSI is Based on 14 Days Prices MACD is similar concept based on much longer time series of prices, and measures longer term momentum Not an index, can take on positive or negative values 0 means no trend Positive means positive trend, higher the stronger Negative means negative trend, larger the stronger We use both to determine divergence and help understand if we have a top or bottom a way to confirm what we see on the bar chart.
March Spring Wheat Bottom: Diverging on RSI and MACD
The Fundamentals of Technicals When a market has several months in a channel like wheat, Interpretation is that no matter what s come out of the bull or bear bag for four months, the market can t justify taking the market outside this $.50 range
Break Outs Once significant resistance or support is on the chart, then a change in fundamentals is reflected in a break out. Break out: two consecutively higher (lower) closes above (below) resistance (support), especially on heavy volume and no divergence. With wheat, poor weather in SA or winter wheat area could take it higher, good weather, poor US export demand could take it lower.
Applying These Concepts to Trading Rules in Markets to Help Overcome Greed/Fear Used July 18 Lean Hogs and Nov 18 Soy Futures or their Futures Options Suggest using it on a portion of hogs. One futures contract = 214-220 hogs Selling futures (Short) now is a temporary substitute for selling hogs in July in the cash market. Can buy back any time until July. Buying back lower is a profit and offsets potential loss on a lower cash market Buying back higher is a loss and offsets potential gain on a higher cash market
July Lean Hogs, Dec 2.
July Hogs on Dec 2 Multiple tops at $84 Near highs of 2015, 16 and 17 Major divergence on both RSI and MACD Weak key reversal on Nov 30 at $84.10 high
Trading Rules Sell futures now, locks in a good price in a falling market Risk is you will get priced too low and pay margins Can be addressed with the breakout rule ie buy stop on your short position on two consecutively higher closes than $84.10. Or Buy a Put to Establish a floor price, using Fibonaccis and aiming for a premium less than 3% of the strike price The 38% retracement would suggest an $80 Put, currently ~ $3.20 > 3% So move down to a $78 Put, = ~ $2.50. This would give you a $75.50 floor and let you speculate that the cash market will go higher.
July Lean Hogs, Dec 2.
So, Follow What Happened Since Dec.2
Lean Hogs, Jan 7 Relative Strength Index MACD 85 80 75 70 65 60 55 50 45 40 35 30 1.0 0.5 0.0 L HOGS JUL8-0.5 85.5 85.0 84.5 84.0 83.5 83.0 82.5 82.0 81.5 81.0 80.5 80.0 79.5 79.0 78.5 78.0 77.5 77.0 76.5 76.0 75.5 75.0 74.5 74.0 26 3 July 10 17 24 31 August 7 14 21 28 5 11 18 25 2 Septem ber October 9 16 23 30 6 Novem ber 13 20 27 4 December 11 18 26 2 2018 8 15 2
January 7 Got stopped out at $84.50 on January Fibonacci projection is $88, so look for another chance to sell there or another higher level, or sell again on two closes below $84
0 0 84 84 82 82 78 78 77 77 76 76 74 74 Lean Hogs, Jan 26 Relative Strength Index MACD 8 8 7 7 6 6 5 5 4 4 3 3 1 L HOGS JUL8 0.0% -0 86 85 85 23.6% 83 83 38.2% 81 50.0% 81 80 80 61.8% 79 79 100.0% 75 75 24 31 August 7 14 21 28 5 11 18 25 2 Septem ber October 9 16 23 30 6 Novem ber 13 20 27 4 December 11 18 26 2 2018 8 16 22 29 5 February 1
January 26 Never got to $88 But several tops just over $85, Jan 10 25 Lots of divergence with RSI and MACD during that period Key reversal top on Jan 25 Lots of sell signals
0.5 0.0-0.5-1.0 86.0 85.0 84.5 84.0 83.5 82.5 82.0 81.0 79.5 78.5 78.0 77.5 77.0 76.5 76.0 75.5 74.5 74.0 Lean Hogs, Last Friday Relative Strength Index MACD 85 80 75 70 65 60 55 50 45 40 35 30 1.0 L HOGS JUL8 0.0% 85.5 23.6% 83.0 38.2% 81.5 50.0% 80.5 80.0 61.8% 79.0 100.0% 75.0 24 31 7 14 21 28 5 11 18 25 2 9 16 23 30 6 13 20 27 4 11 18 26 2 8 16 22 29 5 12 20 26 5 12 19 26 2 9 August Septem ber October Novem ber December 2018 February March April
Lean Hogs Today. Still short at best, so paper gain of ~ $85 - $75 At worst, took a profit just above $80, resold at ~$79
November Soybeans Today Relative Strength Index 85 80 75 70 65 60 55 50 45 40 35 30 25 MACD 15 10 5 0-5 -10 SOYBEANS NOV8 1055 1050 1045 1040 1035 1030 1025 1020 1015 1010 1005 1000 995 990 985 980 975 970 965 960 955 950 945 940 935 930 925 920 915 31 7 14 21 28 5 12 19 27 3 9 17 23 30 6 13 21 27 6 13 20 27 3 10 17 24 1 8 15 22 30 5 12 19 26 3 10 17 24 31 7 14 21 28 5 11 18 25 2 9 16 23 30 6 13 20 27 4 11 18 26 2 8 16 22 29 5 12 20 26 5 12 19 26 2 9 Novem ber December 2017 February March April May June July August Septem ber October Novem ber December 2018 February March April
Nov Soy Today When Soys went through Resistance at $10.28 ¾ in mid-february, no divergence on either RSI or MACD, so no sell. No significant divergence at new high No two consecutively lower closes below $10.28 ¾ since the breakout, So, no sell signal yet.
Summary Forces me to take a view of where the market is relative to it s recent past helps identify highs and lows Can be used for forward contracting, don t need to use futures and options to get value from the chart. Obviously, not always going to be right, but Helps identify places with high probability of doing well on futures or options Helps reduce losses by limiting margin payments, Or Helps retrieve some of any price appreciation after contracting with Calls Gives disciplined decision rules that keep losses fairly small