Why Seasonal Trades Are the Solution to Market Volatility

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Given all the volatility in the markets of late it might be time to try something with a high probability – though not a guarantee – of paying off.

I'm talking about "seasonal trades."

Seasonal trades are moves you can make in the futures markets, or now via exchange-traded funds (ETFs), that have a history of producing a profit.

Let me explain.

Seasonal trade opportunities arise from patterns that occur at specific times of the year. They are most apparent in the agricultural sector, where changing weather patterns have an impact on prices.

For example, one such seasonal trade – a bullish October sugar play that has posted a perfect record over the past 15 years, producing an average profit of $1,035 per futures contract in seven weeks or less – launched in mid-June.

That particular trade is keyed to the June conclusion of the sugar harvest in Mexico, the last of the year in the Northern Hemisphere. After that, existing stocks of sugar start to decline and prices are subject to weather scares that could disrupt Southern Hemisphere harvests and new-crop growth in the North. As a result, sugar prices typically tend to rise from mid-June through late July.

Opportunities for seasonal trades are by no means limited to agricultural products. They occur in almost every futures market, including petroleum products, precious metals, stock indexes, and currencies. Often, the reasons underlying these price patterns are obscure, particularly in some of the financial markets, but the reasons aren't nearly as important as the fact that the patterns repeat – and do so consistently year after year.

Moore Research Center Inc. (MRCI), a leading commodity markets statistical firm, tracks more than 250 seasonal trades each year (along with a similar number of intra- and inter-commodity spreads), advising subscribers on the top 15 positions that can be entered each month. To qualify for listing, a trade must have been profitable at least 80% of the time over the prior 15 years – although most, like the sugar trade cited above, have even stronger records.

Similar records and recommendations are provided by SeasonalTrader.com, which follows a wide array of what it calls High Odds Seasonal Trades (HOSTs) and tracks records as far back as the 1960s and 1970s.

There's no question that seasonal commodity price patterns exist – and they can offer major profit opportunities to knowledgeable traders in the futures markets.

But what if you can't afford the large margin deposits required to trade many commodities, don't have a futures trading account, or simply aren't comfortable with the high risks that go along with playing these markets? Is there a way you can get in on the seasonal action?

Up until a few years ago, the answer was usually "no." The only alternative to futures for making such plays was with equally risky and highly leveraged commodity options. However, thanks to the recent introduction of so-called "pure play" ETFs, it's now possible to make seasonal commodity trades in the comfort of your stock brokerage account, with no more cost or risk than you'd have with any purchase of regular common shares.

ETFs and Seasonal Trades

Although the ETFs don't yet have the long-term track record of the commodities on which they're based, their short-term performance seems to indicate they track the seasonal price moves in the underlying futures fairly closely.

Let's look at a petroleum-complex seasonal trade that calls for entry in late July – meaning there's still time to play it.

According to Moore Research, the price of the September crude oil (CL) contract traded on the NYMEX (New York Mercantile Exchange) division of the CME Group has risen from around July 23 until early August in 14 of the past 15 years (a 93% success rate), producing an average profit per trade of $1,278 per contract.

The rationale for this trade is that gasoline consumption hits its highest level in August when driving conditions are best and many families vacation prior to the start of school. Preparation for this demand increase leads to a drawdown in refinery crude stocks, which must be replenished prior to an even sharper rise in demand for heating oil that comes in the fall. Thus, refiners tend to buy more crude during this period, sending prices higher.

As proof of that, prices for September crude oil futures rose from $67.16 a barrel to $69.45 a barrel in late July 2009, and from $78.96 to $81.34 in late July 2010, gaining $2.29 a barrel and $2.36 a barrel, respectively. Since each futures contract represents 1,000 barrels, that equated to respective profits of $2,290 and $2,360 per contract – in roughly 12 days.

Had you chosen to play that seasonal trade with an ETF, the best choice would likely have been the United States Oil Fund LP (NYSE: USO), recent price $35.36. (Note: There are currently five other crude-linked ETFs offering both long and short exposure to oil, as well as 200% leverage in both directions.)

In 2009, you could have anticipated the seasonal move by entering on July 22 at a price of $34.01 per share – and you would have been quickly rewarded. USO prices rose steadily for two weeks, peaking at $38.27 on August 6. Had you closed the next morning on the assumption the seasonal trade had run its course, you could have sold at $38.15, scoring a gain of $4.14 per share, or $414 per 100-share lot. Had you bought 1,000 shares to mirror the size of the 1,000-barrel futures contract, your gain would have been $4,140 – even better than the profit scored by the futures traders.

An almost identical scenario played out in 2010, when prices for the USO fund closely tracked futures prices, climbing from $34.20 on July 21 to $36.91 on August 3, good for an 8% profit in just 14 days – or $2,710 on a 1,000-share position.

Obviously, with Moore Research suggesting 15 seasonal trades per month, all having an 80% success rate or higher, we could cite numerous other examples – but we won't. Rather we'll just note that seasonal moves – either up or down – in July are projected for commodities such as sugar, cocoa, heating oil and natural gas, corn, soybean meal, oil, and silver. Other seasonal trades involving currencies include the Canadian dollar, British pound, Japanese yen, and 30-year U.S. Treasury bonds, among others.

ETFs aren't available on all of those commodities and financial instruments, but they are on many.

Be aware, however, that you should never rely solely on past seasonal tendencies when initiating a new trade – whether with futures or ETFs. Even when you're dealing with a strategy that's worked 80% to 90% of the time for a decade or two, it's a bad idea to just blindly do a trade without knowing what's going on in the world. So, always review both the individual markets and the overall economic situation and other "macro" factors that could impact your trade before placing your order.

Remember, too, that speculative emotion can strongly impact all of the markets on which futures trade – so always use sound money-management techniques and employ protective stops when doing any seasonal strategy.

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