Seasonality represents a repetitive and relatively predictable pattern, be it in the market or our daily lives.
Since seasonality tend to be stable and repetitive, seasonal trading is also a highly reliable trading approach that investors and traders adopt in their trading system.
In this post, let’s learn about seasonal trading, and the benefits and risks of this trading style
Benefits of seasonality in trading
One example of seasonality in our daily lives is the daily temperature in a year, where summer tends to be the warmest time of the year, while winter being the coldest time of the year.
Likewise, there are also various seasonality patterns that we can observe in the financial market. For instance, the price of soybean futures tends to make a seasonal low at harvest time during October or November:
From the example above, it shows seasonal pattern in financial instruments can be relatively reliable – as long as the fundamental reasons that cause them to happen stays intact.
How to spot seasonality/form seasonal trade ideas:
Spotting seasonal patterns to form potential trade ideas can be simple. I always recommend to begin with patterns that we are familiar with, such as:
Financial products and commodities of which its supply and/or demand is influenced by weather (eg. 4 seasons, tropical dry and rainy seasons) such as natural gas, crude oil, and lean hogs, and more.
Financial instruments that are influenced by fixed-schedule corporate routine like dividend-payout.
Next, let’s look at a few examples of seasonal pattern playing out in the futures market.
Seasonality in outright futures market
#1 Lean Hogs & Pork Cutout futures
Historically speaking, due to an increase in demand over meat for purposes such as BBQ during the summer, both lean hogs and pork cutout futures tends to display higher prices in early and mid-summer (June - July), and begin to decline at the peak of summer (August) through the end of the year:
#2 Heating Oil
Heating oil is a commodity that is influenced by demand more than supply. Refiners tend to build their heating oil inventories while commercial purchasers will begin their purchase prior to winter in preparation for the cold season.
As a result, heating oil tends to trend higher from July onwards (during the summer) to October despite demand towards heating oil is low during the summer.
Seasonality in spread trading
Seasonality can also be found in spreads between futures contracts. Here are some examples:
#1 Natural Gas Spread:
With global warming happening, winters in the US over the past decades tend to get warmer, leading to reduced heating demand, which results in lower natural gas consumption.
As such, the premium of natural gas futures contracts in winter months (eg. February) relative to post-winter months (eg. April) tend to become smaller with time.
This seasonal pattern can be translated into a spread trading idea by shorting a February (G) - April (J) Natural Gas calendar spread:
#2 Lean Hogs Spread:
The demand for lean hogs usually rises during summer months due to an increase in meat consumption for occasions such as BBQ.
As such, prices for the summer month lean hogs contracts are usually at a premium over the pre-summer month contracts.
This seasonal pattern can be translated into a spread trading idea by buying July Lean Hogs and selling April Lean Hogs contract:
How to trade seasonality:
Since seasonality trends tend to be repetitive, they can be utilized in various trading approach:
#1 Trading seasonal trend on its own
Trading seasonal trend on its own can be a rewarding approach for traders with strong fundamental understanding towards seasonality.
Using the seasonal trend of Soybean September contract futures (ZS futures, U contract) (price tend to bottom at harvest time in October or November), entering a long position on 2/10, exiting on 1/11 has been working 100% of the time for the past 5 years:
Year | Entry (2/10) | Exit (1/11) | Gain/Loss ($) |
|---|---|---|---|
2023 | 1358.25 | 1407.5 | +$2462.50 |
2022 | 1246 | 1248.75 | +$137.50 |
2021 | 990.5 | 997.5 | +$350 |
2020 | 959.25 | 970.75 | +$575 |
2019 | 923.5 | 925 | +$75 |
#2 Determining trading bias via seasonal trends
Traders can use seasonal trends to complement their trading system as well.
For instance, using the Soybean example previously, intra-day Soybean traders could refer to the bullish seasonal trends in October/November to determine their trading short-term trading bias, and avoid taking counter-trend trades.
Risks and downside of seasonality trading
(i) Seasonal pattern doesn’t always work
Seasonal trading, while tend to have high probability, will have years where things may not work out as planned.
As such, it is crucial for seasonal traders to have proper risk management in place to always be prepared for situations where seasonal trend fails, or it could be disastrous for seasonal traders.
(ii) Overconfidence
Psychologically, high probability seasonal trends can lead to overconfidence in a trader, which could lead to unhealthy trading habits such as poor position sizing, trading without proper management, and more.
Verdict: Learn and take advantage of seasonal trends!
In this post, I shared about the basics of seasonality and various seasonal trends and use-cases across different trading styles and instruments.
I hope it is helpful in your trading journey!
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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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