What futures trading strategies don’t work?

Over-priced and over-complicated futures trading strategies that involve complicated formulas and multiple lagging indicators are typically not conducive to successful futures trading. Many traders feel that trading should be complicated, and feel the need to use complicated trading methods. They relate complication in other professions to the futures market.

However, in the world of futures, simple is better. Success is the result of managing one’s emotions in an effective manner and thinking objectively on a consistent basis. Many people have an issue controlling their emotions as they interact with the market, and this is the main reason why most traders fail to make money in the futures market. Aspiring traders also fail to keep trading simple and do not recognize that keeping their trading simple will keep them calm and collected while they trade. The brain does not like probabilities as it is, and a complicated trading system will only add more questions for the brain allowing the trader to second guess trading decisions. This indecisiveness often leads to emotional trading and can begin a cascade of trading mistakes leading to a blown out account.

What futures strategies do work?

When discussing futures strategies that work and contribute to an objective mindset; we are talking about strategies that are built around simple price dynamics and chart reading skills. A futures trading strategy that works is built around price action. This is the art and skill of identifying specific price patterns. This is much easier said then done, as I have seen many on the internet claim to use price action without actually knowing what it is.

Price action trading is a simple futures trading strategy that will positively impact your trading mindset and help you to maintain clear objective thinking as you trade. It is important to get quality futures training from someone who has achieved success with trading price action setups. By having a coach you streamline your learning and avoid the haphazard futures trading educational journey that most beginning traders take. Most importantly, beginning traders need to realize that they do not need to use complicated futures trading strategies. In the end this will only lead to ruin. Simple is always better in everything even outside of trading. Psychology makes up at least 90% of trading, so by keeping your trading style simple you are keeping stress on the brain to a minimum which is what your goal should be. This is how professional trader’s trade and it is the quickest way to consistently profitable trading.

Trading a Falling Bond Market

Successful trading pits two diametrically opposed ideas against each other and forces the trader to assimilate them into a cogent plan of action. First of all, everything we know, we know from history. We constantly relate the market’s present status to something we’ve seen in the past whether it’s fundamental, technical or pattern based. Secondly, we’re asked to project the implications of the current market’s structure into the unseen future. This week we’re going to discuss the implications of applying historical knowledge of the interest rate complex towards the deployment of mechanical models designed to take advantage of rising rates.

There are two primary steps to this process. Our first step is through analogous research. Analogous research begins when a present situation is recognizable because it looks or, behaves similarly to a pattern or collection of fundamental data that the trader has already experienced. The simplest version is the gut instinct, “You know, this market just feels like… ” A more quantifiable version falls along the lines of, “The last time these factors were in place, the market did… ” Analog trading is the primary basis for pattern recognition. The more often a certain pattern is seen and its results are predicted the more easily they are recognized and traded in the moment.

Empirically applying analogous research to the current interest rate sector yields the conclusion that monetary policy is far more likely to tighten than ease further. Sixty years of Prime interest data yields some ideas of what we can expect if history is any precursor to the future. First of all, rates have been abnormally low for an abnormally long period of time. The last time rates were steady for this long was 1960-1967. The Federal Reserve’s Prime rate has been at 3.25% since January of 2009. More importantly, it has been in a downward trend since August of 2007. A trader’s primary concern is always the trend.

The trader’s next objective is determining a target. These require both time and prices. Over the last 60 years once interest rates begin to move, they move by 73% on average before their peak or trough is reached. Furthermore, it takes an average of 30.6 months for the move to be completed. The extremes over this period include a move as small as 14% in as little as six months to more than 200% over the course of three and a half years. Throwing out the largest and smallest moves in both time and distance leaves us with an average interest rate move of 64.5% in 28 months. I think this blows a hole in the, “bonds are less volatile,” investment theory.

Anecdotally, there have been many headlines and news releases that should be forewarning us that a change in monetary policy is coming. These include comments from Fed Chairman Ben Bernanke as well as large investment managers. Perhaps the most noteworthy of which is Pimco’s decision to start offering access to hedge funds as it moves away from the bond business. Bill Gross has arguably been the most successful bond investor of all time. He has ridden the 30-year bull market in bonds up to $2 Trillion in assets under management. When the King leaves the table it’s a good clue that the free meal is over.

The case has now been made for what to expect out of interest rates as well as the time frame in which we expect it to happen once it begins to unfold. This led me to updating previously deployed interest rate models whose effectiveness became limited due to the artificial manipulation of rates following the economic meltdown of 2008. The simplest model is based on the DCB Bond system, which was published in Futures Truth in 2000. This model basically doubled its initial investment between 1995 and September 11th, 2001. The original version of this program traded both sides of the market and has fluctuated in and out of their Top 10 Bond systems since its publication nearly 14 years ago. Meanwhile the long only version posted a new equity high last June and has been flat for the last year.

Trading program technology has advanced substantially since then. We are currently developing programs using a neural network and selective data slices from rising interest rate environments. The main benefit is that we can train it on the type of market movement we expect it to see. The downside is that due to the small windows of time that rates actually move, we only have an average of a 28-month window to use for both in and out of sample testing per episode. The end result will be something traded on a shorter timeframe and will require closer monitoring during the trading day once it is deployed. Fortunately, the tighter timeframe looks like it’s going to help keep risk in check as well. This is how we intend to use history to prepare us for the future. The only certainty in trading is that nothing lasts or, works forever. Define your criteria and trade within your expectations.

The Bean to Corn Ratio Spread

The recent weeks of hot weather have begun to take their toll on the crops in the field. Primarily, we are witnessing soybean’s greater sensitivity to late summer heat relative to corn. Not surprisingly, soybeans have rallied about 14% since August 8th as compared to less than 3% for corn. The result of this divergent behavior among crops grown side-by-side is that the bean to corn ratio has been elevated to levels that we don’t view as sustainable. Therefore, we’ll look at some reference points for the bean to corn ratio as well as the relationship between these two crops before ending with some fundamental data that forces us to re-think the usefulness of historical data in the face of a fundamentally changing marketplace.

The bean to corn ratio is simply the price of soybeans divided by the price of corn. Currently, November soybean futures are trading around $13.55 per bushel and December corn futures are trading at $4.68 per bushel. The November and December futures contracts represent this year’s crop in the fields, respectively. Therefore, the current bean to corn ratio is approximately 2.9. Beans are 2.9 times more expensive than corn on a per bushel basis. The last time this spread was this high was August of 2009. There have only been four years since 1975 when ending prices for the current year’s crop have closed at a spread greater than 3. According to Carl Zulauf of Ohio State’s Department of Agriculture, the maximum traded price for the ratio is 4.1 in May of 1977. He’s also published the low figure of 1.72 in July of 1996. The average for the spread over the last 45 years is 2.52 while the spread’s normal trading range is 2.19 – 2.85.

Soybeans and corn obviously share many of the same concerns throughout the year and therefore their prices tend to move in the same general directions. Their seasonal characteristics are very highly correlated with the lone notable difference being soybeans’ tendency to remain at higher prices later into the spring due to their later planting dates and associated concerns. Once beans get past July 4th, they sell off just like corn until harvest time nears at which point they both get another boost. The correlation between beans and corn has been positive on a weekly basis all the way back to November of 2012. The daily chart, on the other hand is currently displaying the first negative correlation between these two markets since early May of this year which coincides with typical planting issues.

The United States is still the dominant market maker in both corn and soybeans. However, the rapid expansion of Argentina and Brazil’s commercial farming industry is changing the dynamic of the global corn and soybean markets. This year, the combined output of Argentina and Brazil is likely to be nearly 30% of global corn production and as much as 60% of global soybean production. The combined soybean output of Argentina and Brazil is expected to outpace the US by a third. This must change the way we view the data at hand. This is especially true when studies are produced using 45 years worth of data as the Ohio State piece referenced. The global supply of beans and corn hasn’t been split among our countries. The process has been and will continue to be, additive. Total global production will continue to increase overall with foreign production continuing to grow faster than domestic production.

The marketplace always reflects the participants’ best guess of fair value at the last traded price. Therefore, both domestic and global production rates are considered when trades are placed at the US commodity exchanges. However, more weight is always given to prices in the larger context. Daily highs and lows matter more than those of the last minute just as weekly highs and lows are accorded greater importance than their daily counterparts. Therefore, when markets make multi week, monthly or yearly highs or lows, we pay attention. The soybean rally brings us to levels not seen since last December and has pushed the relationship between corn and soybeans to multi-year highs.

We believe that the latest push in this spread has come from speculative buying in the soybean market. There are three primary drivers of mass speculative action in the commodity markets, all of which lead to whipsaw action at extreme price levels. Tension in the Middle East spurs speculative energy buying. Stock market collapses spur knee jerk selling. Finally, droughts spur speculative corn and bean buying. All three of these situations end up with small speculators left holding the hot potato. The current Commitment of Traders report clearly shows large amounts of small speculative buying heading into the USDA Supply/Demand and Crop Production reports. Considering commercial traders have pared their net position by 25% over the last three weeks, we believe it’s likely that this report could mark the high for the bean corn spread as it returns to its normal trading range.