Two weeks ago in "Breaking Down Soybean Prices," I showed how prices traded in a fairly consistent manner around their 25-day moving average and how separating out this noise allowed us to more clearly see the trend of prices reflected in the slope of the moving average.
I did the same analysis recently for corn prices and found similar results. Where January soybeans showed a standard deviation just shy of 4%, March corn showed a standard deviation of 4.6% around the 25-day average for prices from 2000 through 2016.
As I mentioned two weeks ago, two standard deviations for a normal distribution include 95% of events so I wondered, would it pay to sell corn when prices were more than 10% above the 25-day average and buy corn when prices were more than 10% below the 25-day average? Because these events did not happen very often, I decided to exit the trades when prices returned to the 25-day average.
Using continuous data for March corn from 1995 to 2016, I ran the numbers and the strategy clearly failed. One contract of March corn hypothetically traded as described generated 32 trades and lost a total of $21,337 (no commissions or slippage included).
To review the lesson here, we saw data which clearly showed how rare it was for prices to trade more than 10% away from their 25-day moving average and yet, when we tried to fade the wide price deviation, it turned out to be a losing strategy over time -- why?
It was a little confusing until I went directly to the charts. Looking at March corn prices with a 25-day average and a 10% price envelope above and below the average solved the riddle.
In those rare times when corn prices traded 10% above their 25-day average, something unusually bullish was often happening and the price trend was already clearly higher. Vice versa for when prices were more than 10% below the average. As it turns out, it was more important to pay attention to the price trend than it was to pay attention to how far prices were above or below their moving average. Even when the separation was unusually wide, trend still rules.
Realizing this took me back to earlier days when I worked as a broker here in Omaha. The Relative Strength Index (RSI) developed by Welles Wilder was a popular indicator at the time and was supposed to identify when prices were overbought or oversold.
However, I noticed that customers did not do well when they tried to use RSI as overbought conditions tended to stay overbought and vice versa. Whether we understood the reason why prices were up or down didn't seem to matter -- stronger-than-normal price moves typically had enough of a reason to fuel the trend in their direction.
Here in mid-February, corn, soybeans and wheat are all trending higher with no signs of turning yet. In the case of Chicago and K.C. wheat, the up-trends expanded above their 4% envelopes on Friday, both of which are additional bullish clues. For those playing the game of trying to guess prices by guessing ending stocks, the up-trends are baffling, but markets don't care about our guesses. The current uptrends deserve our respect and, based on my experience, they've earned it.
Todd Hultman can be reached at Todd.Hultman@dtn.com