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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,

  1. Buy December corn futures on October 1st if,

  2. December corn futures are priced below $1.73 and if,

  3. 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.

 

Bruce Gould

 

Always remember that stock, options, and futures trading may involve substantial risks and that past performance is no guarantee of future performance.