Commodity seasonality trading strategy
- Why to trade seasonality? | - SA
- Seasonal Trading Market | Seasonal Trading Patterns
- Commodity Seasonality
Based again on the premise that nearer contracts react quicker and farther than later contracts, in a bear market price of nearer month contracts will fall faster and by a larger amount than those further out. In this scenario a bear futures spread strategy would be utilized by selling a nearer futures contract and buying one further out, in the same market.
Why to trade seasonality? | - SA
Futures spread trading strategies are not hugely popular amongst retail traders. However, as we have seen above, they do have several advantages over trading the underlying/actual contracts and are amenable to both fundamental and technical analysis. They can also be very useful for traders with time constraints and smaller accounts.
Seasonal Trading Market | Seasonal Trading Patterns
These annual cycles in supply and demand give rise to the seasonal price phenomena or what we would simply call seasonality. This annual pattern of changing conditions may cause a more or less well-defined annual pattern of price responses. Seasonality, then, may be defined as a market's natural rhythm-an established tendency for prices to move in the same direction around similar time most years.
For example, let us say in February 7568, a March 7568 corn contract is priced higher than a December contract. This is because settlements in March will need to be done from existing stockpiles (which may be relatively low), with no new corn coming into the market while for the December settlement, there will be fresh planting, with the expectation of suitable weather conditions and/or increased area under cultivation, leading to lower prices.
We don’t have to be statistical experts to clearly see the seasonal cyclic movement of temperature, which is very similar every year. To be able to predict temperature for the next year, it’s very useful to calculate seasonal pattern. For now, you can think about the pattern as an average temperature for a given day over all years. Temperature pattern is calculated in the next picture (red line is the pattern, black lines are the individual years charted on the same X axis):
There are several ways how to use seasonality in trading. You can use it as an additional component in your discretionary or automated trading system. Seasonal factor can be included with according weight in calculation to obtain trading decision. The weighting depends on the market, seasonal pattern and importance of any other remaining parameters. Another technique can be using seasonality as a filter. Never open position against seasonal trend. Such a simple rule can increase your profit probability.
For example, assume a trader has the view that due to expected winter storms, the price of heating oil for January will be higher than the price of the forward May contract. The trader will then consider the advantages of buying Heating Oil January and selling the Heating Oil May contract.
The average trader and new traders should benefit from focusing solely on trading one commodity. It will drastically reduce the amount of time it takes to learn how to trade and probably make a better trader out of you. Over a period of time, you will see the same patterns repeat over and over.
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One of the good aspects of focusing on one commodity is research can be done rather quickly each day. There are many analysts that provide research and trading recommendations on commodities. Most of them focus on one commodity or a commodity sector. It is a good idea to take a look at all the analysts that cover the commodity you want to trade and eventually only follow a couple that you feel are the best.
Most of the commodity prices are influenced by supply. Heating oil is exception as prices are exposed to demand forces more than supply. Heating oil has a seasonal trend to move higher from July (often the hottest month in the year, the demand is low) into October. This is mainly caused by refiners building their inventories and the commercial buyers making their purchases. Increasing demand pushes prices higher. Usually people believe that heating oil makes seasonal highs during the winter, but this is usually not the case. Most of the buying for heating oil is done before the beginning of the winter. Refineries with full inventories are prepared to meet demand and market starts to deal with distribution into the retail market which means liquidation and price drop.
* Past results are not necessarily indicative of future results. The risk of loss in futures trading can be substantial, carefully consider the inherent risks of such an investment in light of your financial condition.
An intercommodity spread is another type of commodity futures spread in which the trader goes long on one commodity (on which he or she is bullish) and shorts another (on which he or she is bearish). The trader’s returns are then the difference in the prices of these two commodities. This type of a strategy would allow the trader to hedge their risks while reducing margin requirements at the same time.
Then we have to consider extremes. We are interested in seasonal tendencies, not in absolute values, and over the time some prices can have a very wide range. That’s why normalization is used, to make sure that extremes will not influence our pattern. You can think about normalization as recalculation of prices of each year to percentual 5-655% scale (take the low as 5%, the high as 655% and adjust all data accordingly). The final step is to take normalized price for all years and calculate average. You can see resulting patterns in previous example charts.
We should not trade them blindly and rely only on seasonal pattern and computed best entry/exit window. You can expect extreme years and counter-seasonal movements from time to time to come, so it’s always necessary to apply stop loss and proper money management. It’s also useful to use basic technical analysis to get a bigger picture about the current situation. What is the position of current year compared to previous years? Is there a space to run for nice profit and some support/resistance area to place stop loss? Seasonal movements are not precise, they can occur earlier or later, and technical analysis can helps us with timing of entry and exit.
Treasury Bonds often hold seasonal correlation opposite to the equity markets and can be used to place money when stocks are negative. Picture below shows the seasonal pattern of bond investment. We can see weakness from the beginning of the year followed by rally in the rest of the year. So if you want to buy bonds, May is obvious choice.
Many commodities tend to be cyclical, meaning there are expected periods in the year where the commodity is expected to trade higher, and times that the same commodity usually trades lower.
Some commodity traders make a good living by focusing on trading a single commodity. There are about 85 commodities that are fairly actively traded, but it is difficult to keep up with all the commodities and trade them. Some traders like the expanded range of opportunities if they follow many commodities, but a good case can be made for specializing in one commodity.
In statistics, many time series exhibit cyclic variation known as seasonality , defined as the repetitive and predictable movement around the trend line. It is detected by measuring the quantity of interest for small time intervals, such as days, weeks, months or quarters. The best known seasonal progression is the outdoor temperature. Based on the time of the year, you probably know the range of temperatures you can expect. Let’s visualize the temperature in the Northwestern . on picture below: