Trading Educators Blog
Relationships Part 1
Any pattern that remains accurate over long periods of time merits notice. If the current market conforms to that pattern, trading potential appears.
Is a seasonal strategy with unblemished performance due to fail?
Such a question subscribes to the random-walk theory of price movement. It certainly ignores the probability that a pattern might have a seasonal effect and be caused by a seasonal fundamental. Any trader who believes that price movement is no more predictable than the flip of a coin is a gambler.
I'm not trying to say that any pattern will always work if applied rigidly. Markets are dynamic. They are organisms that live and breathe. The daily noise of news and the interplay of macro- and micro-fundamentals can disrupt the normal ebb and flow of an underlying seasonal fundamental. To place any pattern on a pedestal is to invite complacency — and, ultimately, court disaster.
For the very reason that markets are dynamic, any pattern that does evolve deserves respect. But it also is reason to require appropriate price behavior.
Let's look at the relationship between the bi-products of the soybean — meal and oil — the crop marketing year for both of which begins in October. Soymeal constitutes a long-term average of about 65% of product value. With consumption of this livestock protein supplement greatest during the Northern Hemisphere's winter, commercial activity — and soymeal's product value — peaks in the fourth quarter.
With consumption lowest in summer — and looming export competition from Brazil's new crop, soymeal's product value typically declines into March. By then, the market has often discounted the prospects of reduced immediate demand and large new supply, and the market must begin anticipating fourth quarter demand. Because price precedes consumption, the second and third quarter is a seasonal transition during which soymeal's product value increases from lowest to highest.
Around late April in any year, you might want to look at going long August Soymeal and short August Soy oil.
If you don't know how to chart this spread, you might think about learning more about spread trading. To see it properly, you must multiply each side of the spread by its unit value. You also need to check with the exchange for the possibility of reduced margin if done in an approved ratio. The last time I looked, the margin was reduced by 50%. It's really true that you get more "bang for your buck" with spreads.
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