Lesson 13: Building a Plan - Part 2
 When you start
to develop a plan, and remember that a great
plan may end up being the most valuable asset that you pass along to
your children, you realize that certain quirks or
idiosyncrasies stand out in markets. Let's look briefly at the corn
market highlighted in lesson 12. If you
examined this market yourself, you noticed two patterns that seemed
to stand out. The first was that if you divide the corn market into
ranges from 101.50 to 389.00 you find that within each quarter
section of prices the numbers of winners and losers are fairly even
until you get to the range between 101 and 173. Here the winners
outnumber the losers two to one. You have 5 losing trades and 10
winning trades. Now, if you are going to the race tracks on Monday,
Tuesday, Wednesday and Thursday and you discovered that for some
strange reason when you return home on Monday, Tuesday, and Wednesday
you always break-even for the day, but when you return home on
Thursday you have twice as much money in your pockets as you had when
you left home in the morning, which day of the week do you think
would be your favorite? If you discovered that every Thursday you
were able to win on 2 out of 3 bets, but on the other days you were
only able to break even; wouldn't you favor Thursdays?
If you buy December corn futures on October l and sell December corn
futures on December l and discover that when the market is priced
below $1.73 you make a profit twice as often as you suffer a loss,
wouldn't you like buying December corn futures on that date in that
price range? Now, looking at the years when prices were below $1.73,
what if you discovered that in the years when you suffered losses,
the market was in a sideways to uptrend 100% of the time but in the
years when the market was in a major downtrend on October 1st, you
did not have one single loss, wouldn't this interest you?
If your research were to show that every major downtrend market on
October 1st made you money, you can then start to develop your plan
for trading corn in the fall. Whenever December corn futures are
selling in the bottom quarter price range and are in a major
downtrend on September 30th, historically one has always made money
by buying on October 1st and selling on December 1st. There is no
guarantee that this will always work in the future, but historically
this looks like an interesting fact. You might start to write out a
plan that would read like this,
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Buy December corn futures on October 1st if,
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December corn futures are priced below $1.73 and if,
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December corn futures are in a major downtrend on September 30th.
As I said, there is no guarantee this little plan will make you
money. All one can say about it is that whenever this happened in the
past 40 years, the trader made money. Again, there is no guarantee
that this plan will ever make you money, but it has made traders
money in the past whenever they used it.
Why might this plan work? Let's think about that for a
while, as this thinking process might help you develop other plans
for the future. The first observation to make is that the month of
October is normally the start of the harvest of corn. If you buy on
October 1st, you are buying at the start of harvest. Now, if this
plan should work for you in corn, you can turn to other commodities
that may have a harvest cycle and test out a similar plan in those
commodities too. For example, if you wanted to test this plan out for
buying wheat, you might try the dates of buying December wheat
futures on July 1st and selling December wheat futures on December
1st to see if the successful plan you developed for corn worked when
applied to wheat during wheat's harvest time. The second reason that
this plan might work, the fact that in the past this plan never
produced losers whenever the October 1st corn purchase was made
during a major downtrend in prices, is that the price of corn may
have been moving down in advance of the event. In other words,
harvest is coming and so prices drop and when harvest actually
arrives on October lst - this may be the time to buy. The decline in
prices may have occurred in anticipation of the event.
Now if you applied this corn plan that you have developed to wheat,
you might also wish to see if a decline in wheat prices up to June
30th means that one might consider buying wheat for a rally into
December but an advance in wheat prices prior to July lst, might make
one more cautious about buying futures. The possible conclusion you
reach might be: If there is price weakness coming into harvest,
this could be the time to buy? If there is price strength coming into
harvest, this might not the time to buy? How does one decide
if either of these trading rules is worth making a note of for future
reference or for use in the plan that one is developing for trading
wheat? The best way would be to take a look at the back charts for
the futures contract you are considering trading and see what
actually happened in the years where you had price strength or price
weakness coming into harvest.
In lesson 12, we said we would take a look
at losses in this lesson. With regard to December corn and the period
from October l to December l, you will find no clear pattern of
losses from a simple examination except for the pattern noted above.
The losses are a little greater in the third bracket from the bottom,
in the range between $2.45 and $3.17 and so one might be cautious
when trading in that bracket if one were using the same plan that
might be used when prices are between $1.01 and $1.73. This is
what happens even with some of the greatest plans. They work
very well at particular times of the year and at particular price
levels and that is the only time when you use them. It is a bit like
staffing a basketball team. If you can have Michael Jordan and all
the other great players on your team that Chicago had the past few
years, you may have a winning program. When everything is in place
and all the conditions are met, you have victory. But when the
greatest players have retired or moved to other teams, success may
not be as easily achieved. In futures trading, this is simply how
things work and you have to adjust yourself to how things work
because how things work will never adjust itself to you. If you
develop a great plan which works well between the months of July and
December but only if you have a downtrend in futures
prices and only if the cash price of the commodity you are trading is
above the futures price (a positive basis) rather than below it (a
negative basis), then go ahead and use your plan during the
periods of time when these events are present and put your plan on
the shelf until these events occur.
I have a Pork Belly plan that requires certain things to happen in
the fall of the year. If these things happen, I pull the Pork Belly
Plan out and brush it off for trading in the spring. I have a Live
Cattle Plan that requires that certain events to occur by the end of
January. If they occur, then out comes the Live Cattle Plan on
February l. One might develop a plan correlating the price of coffee
when it is at different price levels similar to the price of corn or
wheat or cattle or pork bellies. Your plan need not be limited to
commodities that have a life cycle. You can develop plans that relate
the bond market to the S&P 500, or the price of silver to the
price of platinum, or the price of lumber to interest rate patterns.
There are many different plans that one can develop and the best way
to start a plan is just like we did for December corn. Pick a
date that seems to be significant - such as the start of harvest.
Pick an event that seems to be significant - such as a decline of
prices into harvest or an advance of prices into harvest then
take a look at past history to see if you can determine any patterns
that stand out. Realize that patterns that might not stand out at one
price level may stand out at different price levels. Make a few notes
to yourself that are very simple and very easy to understand. Use
these notes for future reference. Remember that you are working
on something that you may one day pass on to your children.
Most great plans do not fall out of the sky one morning as you walk
to the office or hit you on your head as you start to get into your
car. They are arrived at by the same process as everything else in
life that works is arrived at; very little luck, lots of hard work,
some intelligence, trial and error, a checking into past history,
using your thinking cap to decide why this plan should work the way
it does, and testing the plan in all types of markets and at all
price levels to see where the plan works for the very best.
Should you buy December corn futures every October l? I would
say no. Should you buy December corn futures on October l in
years when the price is below $1.73 and the market is in a major
downtrend? I would say this: Take a look at your charts. If you did
just that, "How deep was the water" and "How long did
you have to hold your breath" in the years in the past when this
plan was followed? If the water was shallow and you did not have to
hold your breath long or at all, I would say this would be something
you should very much consider doing. However, October l of 2000 is,
as Rudyard Kipling once wrote, "long ago and far away" and
July l of 2000 is much closer. What normally happens when one
buys December wheat on July 1 and sells December wheat on December l?
Is there a pattern in this trade that might be put into practice and
might be worth considering as the basis of a trading plan for you and
perhaps your children? Especially this year when wheat prices have
been on the decline? Is the wheat market something we should now take
a look at to see if there is a plan hidden somewhere within that
market? Yes, the wheat market is worth our time. We will take a look
at it in lesson 14.
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