Lesson 44: Why Mrs. B bought Chicago May Wheat Futures
Mrs. B had some extra time in early September 2001. She used
this time to look over the set of price graphs she owned of Chicago
wheat prices. Looking at the then current price of wheat she
noted that the market had been weak coming into harvest. It is
not unusual for wheat prices to decline into the June-July-August
period of time. Harvest weakness did not surprise Mrs. B.
What did get her attention was the fact that Chicago May Wheat
Futures were selling at around $3.00 on September 1 of 2001.
$3.00 seemed, to Mrs. B, to be a price worth looking into. It
didn't seem high, it didn't seem unbelievably low, but it did seem to
be a price worth looking into. She decided to check things out
by going to her set of 42 price graphs that showed the daily price of
Chicago May Wheat Futures for every year from 1960 through 2001.
The first question she asked herself was this:
In the last 42 years, how many times could one have made money
simply by buying the Chicago May Wheat Futures contract on or near
September 1st of any given year and then selling this same position
on May 1st of the following year?
To answer this question, Mrs. B. took her graphs, and started going
through the years, one-by-one. She would look at the price on
September 1st of each year and compare that with the price on May 1st
of the following year. She wrote down the differences on a
sheet of paper. It was a very simple research project, it
couldn't have been much easier, but it was one that Mrs. B enjoyed
for a very good reason. It made her proud to do her own research.
The only aid she needed was a set of 42 graphs to examine. She
didn't need help from her neighbor, from any friends, from her
husband, from anyone. She only required 42 graphs of Chicago
May Wheat Futures prices and a little time. She was determined
to do this research on her own and arrive at her own conclusions, an
independent lady making her own decisions. She was proud of the
process she had adopted, but she was not satisfied with the initial
results of her research.
Mrs. B found that while it is possible to make money using this
approach, the odds of doing so are not overwhelming and, in addition,
there are so many years when the decline in price between the month
of September and the following month of May is so great that, unless
a trader has a lot of money in his or her account, it would be
difficult to hold a position during this time at even the one
contract level.
In futures trading there is the "drawdown". This is
the paper loss that one suffers while waiting to make a profit, which
may or may not ever be realized. Suppose one were to buy wheat
at $5.00 and hold onto a position while prices declined to $3.00 and
then advanced to $5.50. The maximum possible profit out of this
trade might be 50 cents or $2,500 per contract traded, if one
achieved the maximum, which one almost never does. But what
would catch any trader's eye would be the fact that, in this example,
the "drawdown" before any possible profit could be realized
would be $2.00 a bushel or $10,000 per contract. One would be
risking $10,000 for a maximum profit potential of $2,500.
Clearly, such a risk/reward ratio is not one that a prudent investor
would accept.
Most certainly Mrs. B, in looking at all 42 years in her set of price
graphs, could not accept a program that simply bought Chicago May
Wheat Futures on September 1st of any given year and sold the same on
May 1st of the following year. This was a program that not only
did not show a high probability of success, it was also a
program that often involved large "drawdowns".
Mrs. B decided to refine her research, once again, all on her own,
without any help from her neighbor, her friends, or her husband.
She loved them all, but she wanted to do her research on her
own. Whatever decision Mrs. B made, she was going to make it on
her own. She would reap the benefits or suffer the losses on
her own, as an independent woman making her own independent decisions
within her framework of $5,000 risk capital in which she could trade
commodity futures. The next step Mrs. B took was the following,
she asked herself,
Suppose that I look at only those years when Chicago May Wheat
Futures are priced at $3.00 or lower on September 1st of any given
year. By examining only these years, how many times could one
have made money simply by buying the Chicago May Wheat Futures
contract on or near September 1st of any given year and then by
selling this position on May 1st of the following year?
When Mrs. B asked herself this question, she was surprised with the
answer. She was especially pleased to note that the historical
"drawdown" was much less. It makes sense, really, to
find that the "drawdown" would be less. Wheat at
$3.00 a bushel has less room on the downside than does wheat at $5.00
a bushel. If, in your research, you throw out all years when
wheat is above $3.00 you are probably going to get less risk in any
given trade because prices in the years you are examining are
relatively low. From the 42 Chicago May Wheat Futures charts
that Mrs. B was now looking at, she found about 20 that seemed to
meet her requirement of price being $3.00 or below on or around
September 1st of any given year.
Mrs. B then concentrated her research on those 20 years and forgot
about the years when wheat was priced above $3.00. When she
completed her research, Mrs. B liked the bottom line. There
were two things that interested her. She concluded that the
probability of making a profit in the Chicago May Wheat Futures
contract was attractive, coupled with the fact that the
"drawdown" she might face if she bought in September and
sold the following May was substantially reduced when compared with
the results of her previous research. This especially appealed
to Mrs. B with only $5,000 capital to risk.
Mrs. B was becoming independent. She was learning how to do her
own research and how to arrive at her own conclusions. She was
even to the point where she could call her commodity broker and give
her broker buy and sell instructions without having to wait for the
broker to call her with trading suggestions. All she needed was
her set of 42 charts of Chicago May Wheat Futures contracts and her
pen and paper. Mrs. B was not yet done with her research, but
she was ready to proceed with the next step. To learn out
what that step would be, proceed to the next lesson.
If, before proceeding to the next lesson, you would like to order a
set of 42 price graphs of Chicago May Wheat Futures from 1961 through
2001, in order to learn how to become an independent trader yourself
doing your own independent futures and options research, click
here.
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