Midwest Rains Creating a Bullish View of Wheat Futures

Wheat Futures

Wheat, like all crops, needs a good amount of rain to grow, but not too much. The recent deluge in the U.S. Midwest is causing some people to get excited about wheat.

Trading commodities is by no means a simple task, especially if you are basing your trading upon fundamentals. This all appears to be much simpler than it actually is, like people seeing more rain in the Midwest lately and seeing this single fact as an opportunity to profit from trading wheat futures.

We even see articles in the media which suggest this as well, and people reading the articles may even get excited enough to buy some wheat contracts. This all involves a level of understanding of the futures market that is completely naïve.

Sure, the weather indeed can affect things like the price of wheat, to the extent that it reduces supply. If you want to trade these ideas though, this requires more than just looking at the weather that has happened, as you’d actually need to go back in time and find a working crystal ball to foresee these events to get in before the rest of the world knew about this.

By the time we become aware of these things, by the time the rain has hit the ground in this case, it’s already too late to capitalize on it. You can bet that the farmers and the companies buying this wheat are already well on the case and the market prices in these things at the moment that they occur.

Whatever effect this rain has had on prices has already been accounted for, and completely accounted for in fact. The futures market is nothing like our seeing this and expecting to pay more for food once this works its way down the pipeline, which can take quite a while actually. The harvest is less, the wheat eventually gets sold at a higher price, users factor these additional costs into their products, retailers adjust their prices upward, and so on, all the way to your paying more for your cereal eventually.

The futures market is where this pipe begins though, where these anticipated higher prices get added to the price of contracts, and this happens not in a few months, it happens in real time. You can’t get weather data faster than these futures traders by reading articles on them because futures traders get this data as it happens, with this only even talked about later.

Forget About Beating the Pros at Their Own Game Without Any Real Skill

There is always a degree of speculation about these things though, and the amount of pricing in that these events get and how it all plays out in the end can differ, depending on how well our predictions of these effects along with everything else going on in this market will pan out.

If we think that, as amateurs really, we can out-speculate the professionals on effects of fundamental changes, whose knowledge of, say, the wheat market and wheat futures run much deeper than ours to say the least, this is perhaps even more naïve. We’re really left to guess here and our guesses need to be better than the much more informed ones that the professionals are making, and guessing that they have underpriced a weather event like this with nothing really to justify the belief just doesn’t cut it or even come close.

This does not mean that individuals cannot speculate on things like wheat futures, but you simply won’t be able to do this effectively by looking to fundamentals, including the weather. This at a minimum requires that your level of expertise and the extent and quality of your research be not only on par with the industry average, it needs to be superior enough to establish enough of an advantage to overcome your trading costs as well as to achieve a big enough profit to exceed what else you could do with your money.

You also need an extra advantage to account for the added risk involved, and commodity futures trading does involve a lot more risk than just buying stocks. We’re going to need a real advantage trading this way, one that is way beyond what would be reasonable to achieve or even reasonably aspire to.

There are lots of people who don’t get any of this and will insist on dabbling in commodity futures on this basis. While lots of people can make money with stock investing, commodity trading is net neutral. This means that, when we factor out trading costs, each dollar of profit someone makes will result in a dollar lost by someone else.

If we trade futures in a way that we put ourselves not at an advantage but at a real disadvantage, over time we’re going to be among those who are donating their money to the more skilled participants.

Trading futures is, after all, trading, and even with the right knowledge, trading successfully requires quite a bit of skill. You buy some wheat for instance and it turns out that you guessed right this time, but the price of the contract can bounce up and down a lot. If you don’t know how to handle this, you may exit too soon or hang on too long for your own good, or enter and exit too many positions in your confusion.

You may see the price move against you and reason that it is not only time to be out but to go the other way. You get out, go the other way, but it turned out that this momentum that got you out has shifted and instead of staying in and recouping your losses, you add to them by being on the wrong side of this trade as well.

These mistakes get greatly magnified by the amount of leverage used in trading futures, and if you don’t have a trading advantage, you just end up magnifying your losses, which is not a very exciting thing to see happen, especially when you see the punishment this can deliver on your account balance.

As individual traders, if we’re really looking to gain an edge with commodity trading, we have to rely on technical analysis. Mastering and using technical analysis to take advantage of movements in price simplifies things to what would be similar to trading stocks based upon price movement, where you are just looking to ride the waves and don’t really need to even be concerned about the why of the matter.

We need to realize though that this is all a numbers game, and we’ll be on the wrong side of plenty of trades even when we use this with the utmost of skill. However, given that we only need to make money on balance, if we are good enough at this, we can indeed establish some real advantages which can be well multiplied through leveraging to achieve returns that would make any unleveraged stock investor green with envy.

If you take a nominal return of 5% on something, and you multiply it by 20, as you can with wheat futures, we now have a total return of 100% instead of the much more boring 5%. This is what attracts so many people to the futures market, but we first need to be clear that we are multiplying the right thing, advantages, not disadvantages.

Adequately Preparing for Futures Trading is Quite Involved

Trading futures without sufficient practice doing this with play money is just a crazy idea actually, even though this may appear to be pretty easy at first glance. This game is a much tougher one than trading stocks, even when approached the right way, and if we aren’t doing that, we’re just setting ourselves up for massive failure.

There’s money to be made here though, real good money actually, for those who get the right education, but you shouldn’t go to college until you graduate from regular school, even though this college, the futures market, will gladly take your money if you think you can do well with little or no preparation.

At some point, we do need to step up and use real money, and trading with real money is very different than with trading a demo account. Futures contracts require relatively large margin deposits, amounts that can have us really getting hurt if we’re not able to deal with the psychological pressures that this involves, which get magnified as well with leverage.

If we can access these markets through contracts for difference or CFD brokers, this can allow us to make the transition to real money much easier, because unlike with trading the actual futures, we can start small and work our way up. This is not allowed in the United States currently, although you can still enjoy the benefits of CFD trading by trading currency pairs, and the education here is similar enough to trading commodities to be of real benefit to your trading education overall.

Wheat futures may be in for a bullish move soon, but it isn’t old news that is telling us this, it is the prospects of a continuation of the rebound off of the low of March 11, which has currently stalled a bit. If we bought a couple of days later, once the bottom got laid down, we’d be up pretty nicely right now, but this move does show some potential to move further if we can get over the high of the move on March 26. We got close to that last Thursday, and we don’t just want to jump in when we get a tad higher than this, but a couple of days of positive momentum added to this might be enough.

The most important aspect of this play is looking at how volatile wheat futures have been over the last two months, as we need trends to be large enough if we’re looking to trade this market in this timeframe. We certainly have that though right now, with this current uptrend standing alongside the very heady 15% decline we saw in less than 5 weeks.

If we played that move reasonably, and waited until all the recent support points broke, we could have tripled our investment in this brief period of time, but do not think that this is something those not properly trained could have spotted and managed properly.

The rewards can be much higher with futures trading, but the difficulty level is higher as well, as is the risk. We need to make sure that we are really up for the task and especially not let ourselves being guided by ignorance or mere desire.

Eric Baker

Editor, MarketReview.com

Eric has a deep understanding of what moves prices and how we can predict them to take advantage. He also understands why so many traders fail and how they may help themselves.