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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

 

            Bruce Gould

Proceed to lesson 45 by clicking here.

 

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