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Kub's Den
Wednesday, May 25, 2016 2:32PM CDT

By Elaine Kub
DTN Contributing Analyst

Satiated by a barbecue sandwich and some German potato salad at my neighbor's recent high-school graduation party, I admired the decorations placed on folding tables throughout the 4-H event hall. There were mason jars filled with lilac blooms, framed senior photos, snapshots of trophy-winning steers and sewing projects, and a hand-painted "Advice Box" inviting all the guests to write down and drop into the box a piece of advice for the graduate as she approaches college and adulthood.

Golly, do I love being asked for advice! It's the best part of growing older; there is an ever-increasing population of people who think you've got it all figured out and who come to you for wisdom and guidance. My neighbor's graduation advice box reminded me of an email I received from a young man out of the blue a few months ago.

"I recently purchased a Kindle version of your book and am slowly learning the grain markets," he wrote, and then he followed with some very kind words about the book itself (which, of course, I'm much too modest to reprint here). Then his email continued, "What in your opinion is the best way to begin trading the grain markets, strategy wise? Do you use fundamental or technical analysis, maybe a combination of both perhaps? I have about $10,000 capital to begin trading with. Any advice you would be willing to share would be forever appreciated and in your debt.

"Best Regards,

"Justin

"Sent from my iPhone"

Well, I'm pretty sure we're all thinking of the same one-word piece of advice for this young man who wants to take his $10,000 and start trading grain futures: Don't.

Farmers and physical grain traders spend entire careers trying to minimize their risk exposure to these volatile markets, with prices as wild and as unpredictable as the weather itself. But there will always be some foolhardy souls who want the chance to participate in a 28% price rise within 11 weeks (as soybeans have done), or even the chance to make 15 cents per bushel with a day-trading guess. Putting up $2,300 in margin money for one long soybean contract on March 1 would have yielded $9,600 by now, if the speculator had guessed the correct direction of the market. I'll admit it -- in my younger years, I myself dabbled in some short-term speculation and even some day trading. I would make gains of a few hundred dollars on soybean-to-corn spread trades, or even a few thousand dollars on lucky crude oil trades; but I also remember losing $6,000 one day on a copper bet when the Federal Reserve tweaked its language and the dollar suddenly collapsed. Whoopsie daisy.

Note that I said, "When I was younger." As in, when I had even less money than I do now and was therefore even more desperate to forge any sort of profit. That's a recognized economic phenomenon. Using Kahneman's and Tversky's Prospect Theory, researchers can show that poorer people (people with less to lose) exhibit more risk-seeking behavior. Compared to people with a little more economic security, they have a different frame of reference about how good gains will feel and how bad losses will feel. A young person with not much money and no other employment prospects may feel that the risk of losing thousands of dollars in the corn market is worth it, while someone with hundreds of thousands of dollars to easily deploy in comfortable investment strategies may take a look at corn's volatility and think, "Nah." Wealth, youth, gambling, extreme sports, farming ... it's all sort of interrelated.

That's why my email pal Justin likely won't accept, "Don't do it," as reasonable advice, and he's not alone. The U.N. estimates that global unemployment rates for youth (24 years old and younger) are three times higher than adult unemployment rates. Yet they have the same dreams as anyone, and they want money to pursue those dreams. The Financial Times' coverage of the surging speculative trading volume on Chinese commodity futures exchanges has shown that many of those new speculative traders are otherwise unemployed 20-something men, "looking forward to another week of fevered risk-taking in China's hottest new casino."

Good advice to a heroin addict might be: "Always use a clean needle." In that same spirit, I put together some advice to Justin, the email writer and aspiring speculative grain futures trader.

* Technical trading signals don't always work, but it's nevertheless a good idea to look at a historical chart to see if a market will soon be bumping up against previous highs or lows that might meet psychological resistance.

* It's also a very good idea to KEEP YOUR EYE ON WHAT THE U.S. DOLLAR IS DOING FROM DAY TO DAY.

* Maybe start with some long options (i.e. buy either cheap calls or cheap puts, depending on which direction you think a market will go.) That will get you familiar with the order-placing process and the speed of the markets.

* Once you're comfortable with that, then with your $10,000, and a good fundamental hunch about a market's trend or direction, it would not be unreasonable to go long or short in a grain market using futures contracts themselves (which will earn you profit or loss faster than options), but REMEMBER TO BACK UP EACH ORDER WITH STOP ORDERS, and to remove those stop orders once you've closed each position.

* Once you really feel like you know the markets well, then in my opinion, spread trading (either calendar spread trading or intermarket spread trading) has the best reward-to-risk ratio among commodity trading strategies, but it can take months or years to research and understand a market well enough to spark those ideas.

* Do careful research on the firm with which you open a brokerage account. Human brokers can be immensely helpful for discussing trading ideas, or alternatively, they can tempt you into crazy ideas that just burn through commission fees.

* Keep good records to dispassionately assess your successes and failures, and change your strategies accordingly.

If Justin ever took my advice, he didn't write back to tell me about it. I do know that I also tried saying some of this to my 20-something cousin, who day trades Forex contracts out of his parents' basement, and he shrugged it off and continues to free-wheel along without diligent stop orders. But he is still free-wheeling along, so I guess he's not broke, and that's something of an achievement.

To my readers who are farmers, if you're like me and haven't sold much 2016 grain yet, well let's not get too sanctimonious just yet. Farmers can be grain speculators, too. We can do it directly through a futures account if we feel confident the market doesn't yet realize something about its supply-and-demand fundamentals, and that we can therefore make some money betting on a future price direction.

But we can also be unintentional speculators, exposed to all the same monetary risk, whenever we have unhedged bushels. If you've planted 100,000 bushels worth of corn but have zero forward contracts signed and zero futures or options hedges sold, then that makes you 100,000 bushels long in December 2016 corn price exposure. Who's crazier? Justin with his $10,000? Or you?

Elaine Kub is the author of "Mastering the Grain Markets: How Profits Are Really Made" and can be reached at elaine@masteringthegrainmarkets.com or on Twitter @elainekub.

Trading commodities involves substantial risk of loss. Past performance is not indicative of future results. Opinions are subject to change at any time. THIS ANALYSIS IS NOT A SOLICITATION OR RECOMMENDATION TO BUY OR SELL COMMODITY FUTURES OR COMMODITY OPTIONS.

(CZ/BAS)


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