Any good card player knows that every player has signs, or tells, that clue you into the competitor's hand. Using futures contracts can be like playing a card game, which means the futures market also has tells that you can pick up on – if you know what to look for.
John Lawrence, Iowa State University, has done research comparing futures and options strategies to the cash market, as well as identifying what signs to look for when making buying and selling decisions.
"There are no simple answers. Seldom is there a scenario when the futures market is always considered better than the cash market," says Lawrence. "You need to look at historical data that shows when some tools have performed better than the cash market."
As a general rule, the cash market provides higher average returns than futures and options from about May through August. Various combinations of short- and long-term options average higher from September through November, says Lawrence.
A sound way to determine what the market will do in the future is to look for indicators of a market upturn or downturn. One method of systematically tracking trends will require you to keep track of the short-term moving average and long-term moving average for the current contract. If the short-term moving average moves above the long-term moving average, it indicates the contract price will rise.
For example, if the five-day average on the June contract moves above the 20-day moving average, the contract price is likely headed higher.
That strategy works with varying degrees of accuracy, depending on the particular contract and the exact short- and long-term moving averages that you study. That's where Lawrence's research comes in. The tables on the next page show which moving averages give you the best market indicator for each contract.
For example, if you look at hogs to be sold in mid-May, using a 15-day, short-term moving average and a 42-day, long-term moving average to make decisions over a six-month period prior to slaughter you'll uncover a $5.22 per-hundred-live-weight average return.
Lawrence also determined a risk ranking for each strategy, measured as the 25th percentile returns. The risk ranking is defined as the price needed to put you at the 25th percentile – meaning 75 percent of the time you would receive a price higher than the one listed. For example, the 15- to 42-day strategy for selling on May 15 would yield a return of $6.41 per hundred-weight or higher 75 percent of the time.
The information in the tables shows you what data you should be using to make your futures contract buy and sell decisions. Once you've got that figured out you need to program your computer to calculate the right moving averages. If the best indicators show the market moving down, you know you should consider selling a contract. If the market looks to be going up, that is a buy signal.
Lawrence says that you need to analyze yourself and your operation to decide what kind of strategies to use in the futures market. There are a couple of key factors to consider in order to manage your risk-and-return trade-off.
"First you need to ask yourself if you understand futures and options," says Lawrence. "If you do, then you need to understand when to use futures, when to use options and when the cash market would be your best option."
Then Lawrence suggests that you look at historical data on the contracts you plan to use. For example, if you want to use the February futures contract, determine when you want to place the hedge. You should look at historical data – which shows that the best time to hedge a February contract might be June or October. Of course you want to hit your window of opportunity.
Like the old song says, in cards you have to know when to hold 'em and know when to fold 'em. You can make that work in your favor for the futures market as well.
What to Watch for in the Futures Market
This table shows the short- and long-term moving averages that you can use to analyze signals in the futures market. It shows which strategies have the best return and the lowest risk for each contract month.
The information is broken into 6-month and 10-month hedges, meaning that you begin to monitor the market when the pigs are born or when the sows were bred, respectively. The table is also available at http:// www.econ.iastate.edu/faculty/lawrence/HOGS.htm