Seasonal trading is one of the most common and effective trading styles when it comes to spread trading.
However, it is not without its flaws and downsides.
In this post, let us go through a seasonal trade case study and 2 ways how a trader could refine his/her trading style.
Case Study: Crude Palm Oil Futures (FCPO) spread from May - Sept
FCPO is one of the most actively traded futures instruments in Malaysia.
Unlike the year end where it gets rainy, Malaysia's weather in May - September tends to be moderate.
This normally leads to a higher production for these months, leading FCPO spread to be seasonally bearish between May to September:
Shift in market condition led to seasonal trends failing
However, a seasonal trend is not guaranteed to work 100% of the time.
This is especially true when there is a shift in market conditions.
Impact of La Nina & India's import tax on FCPO spread
In 2024, 2 important events caused a shift in market conditions for FCPO:
Supply disruption: La Nina caused excessive rain in H2 2024, disrupting production.
Demand spike: India, being the top importer of palm oil, raised import tax from 0% to 20% effective 14/9/2024. This caused an increase in palm oil purchases from India before the tax implementation.
The impact?
A spike in demand coupled with a disrupted supply caused an increase in near-term uncertainty.
As a result, this leads to FCPO spread becoming bullish instead of bearish between May to September.
2 ways to refine a pure seasonal trading strategy
The example above has shown a major downside of pure seasonal trading: A shift in market condition could cause it to fail.
The big question is: Are there ways to refine a pure seasonal trading approach?
Personally, I think there are 2 ways to do so:
#1 Outlook Analysis
Outlook analysis refers to a study of the market direction and sentiment. It achieves an important goal:
Outlook analysis allows traders to anticipate potential risks ahead of time.
Using the FCPO example above, the outlook of La Nina (excessive rain) happening between June and August has been reported in late February 2024:
Using this information, traders would be aware of the potential increase in uncertainty ahead of time while trading FCPO as the month of May/June is closing by.
#2 Technical Analysis
Simple technical analysis, such as trend-following indicators could also be used to improve the timing of execution for a seasonal trading strategy.
The addition of technical analysis achieves 2 goals:
Avoid traders from trading against the current trend or price action.
Help improve the precision of trade execution.
From our case study, when FCPO went against seasonal tendency and became bullish between May - September in 2024, traders that apply a simple trend-following indicator, such as the 21-day EMA would be able to avoid going against the bullish (counter-seasonal) trend:
Seasonality + Outlook + Technical = Improved decision-making
Combining elements like seasonality, outlook, and technical could be a great way to help improve the decision-making process for a trader.
Let's put together what we have learned, in reference to the FCPO case study:
Seasonal: FCPO spread tend to be seasonally bearish in May – Sept.
Outlook: News on the potential of La Nina between June – Aug (more rain) was reported ahead of time. [Bullish outlook]
Technical: Price held above 21-day EMA, indicating an uptrend. [Bullish technical]
Refined decision-making:
From this, an insight is obvious: Following seasonal trend for this scenario is likely very risky.
Some decisions could be derived, based on a trader's trading plan and goals:
Skip taking seasonal trades for FCPO spread.
Reducing the size on seasonal trades for FCPO spread.
Taking counter-seasonal trades via trend following on FCPO spread.
Verdict: Use outlook and technical analysis to refine your seasonal trading game.
With this post, I hope it provides clarity on how one could use techniques like outlook and technical analysis to improve their seasonal trading game.
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Disclaimers
Any of the information above is produced with my own best effort and research.
This post is produced purely for sharing purposes and should not be taken as a buy/sell recommendation. Past return is not indicative of future performance. Please seek advice from a licensed financial planner before making any financial decisions.
Leverage is a financial tool that comes with its advantages and risks. Please learn and understand both the upsides and downsides of leverage before using it for trading.
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