Feb/March 1998
Taming the Bulls & Bears
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Prairie Grains is the
official publication of
the Minnesota
Association of
Wheat Growers,
North Dakota Grain
Growers Association,
South Dakota Wheat,
Inc., and the
Minnesota Barley
Growers Association.
It is November 1996 and John Dough is sitting on 20,000 bushels of spring wheat in on-farm storage. The current cash price is $4.20 per bushel and Dough has heard reports that the price could reach $4.50 by early spring.
April 1997 arrives and the local cash price is $3.50 per bushel. This represents an equity loss of $14,000 in cash value on the stored wheat. In the local paper, Dough reads about a possible major wheat purchase by China in the coming months. He decides to hold the wheat a while longer.
October 1997 arrives and Dough is still sitting on the stored durum wheat. The potential "big purchase" by China never materialized because of credit problems. The local cash price falls to $3.20 per bushel. For Dough, this represents an equity loss of at least $20,000 in cash value (from November 1996) on the stored wheat. Dough has several bills that must be paid within the next month. To pay these, Dough is forced to liquidate the stored wheat.
Does this story sound familiar? Perhaps you have experienced this firsthand or you know of a neighbor that has experienced a similar situation. Dough and producers like him are victims of the psychology of markets. In fact, Dough's experience is similar to the experiences of speculators who regularly trade futures and options contracts as an investment. The only difference is that Dough is a speculator in the local cash market, rather than in the futures or option pits.
Webster's Ninth New Collegiate Dictionary defines psychology as "the science of mind and behavior." Commodity markets are places of human interaction where the minds, emotions, and behaviors of the participants combine to discover a market price. Thus, markets often seem to display a psychology all of their own.
For example, a price forecasting technique known as bar chart analysis relies upon the emotions of traders to predict future price movements. Formations on a bar chart represent psychological barriers in the minds of market participants. Often, the market will test these barriers, only to fall short. But once one of these technical barriers is penetrated, the psychological barrier in the minds of the traders is removed. The market will advance until it meets another psychological barrier at a new price level.
To develop the proper mindframe for dealing with your relevant markets, here are some simple rules:
1. Minimize your emotional involvement in the markets by developing a complete and well thought-out marketing plan. It is ironic that most farmers, who would never go on a long automobile trip without a road map, fail to develop a plan for marketing their livestock and crops. This marketing "road map" provides the destination (i.e., goals) and the route to take (i.e., marketing toolbox and strategies).
2. Become active in or form a marketing club. We often see support groups for dealing with many of the emotional traumas of our society. How about a support group for dealing with the psychology of markets? Marketing clubs provide a forum for sharing information, experiences, and education regarding agricultural markets.
3. Always know your market risk position. In the introductory example, John Dough was speculating in the cash market and wasn't aware of the risks he was taking. One of the major reasons that futures and options hedges go bad is that the producer inadvertently gets placed in a speculative position due either to bad advice or the attraction of "playing the futures game."
It is unwise to use operational capital to finance speculative transactions in futures, options, or cash markets. If you want to speculate in these markets, set aside some "venture" capital for investment purposes. Then, if you lose at playing the futures game, you only lose your "set-aside" money rather than your farm. Hedging with futures and options work best when you stay with your game plan.
Commodity markets have a psychology of their own and participants in these markets can become emotionally overwhelmed. As an agricultural producer, it is important that you develop the proper mindframe for dealing with the psychology of markets. This article contains three basic rules that will help you cope with the ever-changing psychology of commodity markets. n
(From the wheat tutorial of the Minneapolis Grain Exchange, by David W. Bullock, senior economist. For more lessons, check out the MGE web site: http://www.mgex.com. For a recorded commentary of each day's markets, call the MGE at 1-800-827-4746. "Taming the Bulls and Bears" is a market education feature of Prairie Grains. If you have a question or topic you'd like to see addressed in this feature, send it to: Minnesota Wheat, attn: Prairie Grains editor, 2600 wheat drive, Red Lake Falls, MN, 56750. Phone: 1-800-242-6118. Email: mnwheat@means.net.)