In this post, let's look at several tips and ideas on how to use seasonal trends in your spread trading journey.
#1 Trade seasonal trend as it is
As I've covered in many prior posts (like this one and this one), seasonal trends tend to be quite consistent in spread trading in the futures market.
For instance, check out how selling a NG Apr/May/June (J:K:M) butterfly spread from 21/11 - 2/10 achieved a 90% win rate for the past 10 years before applying any other form of trading styles such as technical analysis:
Upside:
Spread trading on its own tends to exhibit a strong seasonal tendency compared to outright directional trading. As such, in general, seasonal trends tend to be more reliable in spread trading.
Downsides:
Despite that, we cannot run away from extreme years where fundamental factors that drive seasonal trends may shift.
Seasonal trend is not precise, it may start and end earlier or later.
Tips:
Consider having stop-loss rules in place to protect yourself against extreme years where seasonal trends are off.
Consider using approaches that can help improve entry and exit precision, or help detect trends.
#2 Trade seasonal trends with technical analysis
Coupling seasonal trends with Technical Analysis can be another way traders can improve the overall execution and manage risk.
Let's demonstrate this with an example from Natural Gass futures (NG):
Context: NG Apr/May (J:M) calendar spread tends to display bearish seasonal trend between late Oct - Feb
Thanks (or no thanks) to global warming, the US has been experiencing warmer winter months (Dec - Feb) in the past few years. Since natural gas is used for heating during the winter, a warmer winter means lesser demand for natural gas and larger leftover inventory post-winter season.
Since April and May are spring months, the market may anticipate lesser NG consumption as the spring season develops. As such, there is very little reason to pay for more expensive price premium for NG contract in May compared to April (where there is even less demand for NG as spring develops).
In other words, if all the fundamentals stand true, the spread between NG in April and May tends to narrow with time especially when it comes to the winter season, in line with the bearish expectation of the future.
When the seasonal trend is bearish but the actual market is going sideways...
When the long-term seasonal trend is bearish but the actual market condition is going sideways, traders can consider using typical support and resistance zones to determine entries and exits:
Suppose the seasonal trend is bearish but the actual market is trending upwards, traders can consider waiting for a shift in trend via indicators like Moving Averages to get a more precise entry, while avoiding trading against the actual market trend.
Lastly, if the seasonal trend is bearish and the actual market is indeed bearish, traders can use indicators like Average Directional Index (ADX) to determine if he/she should take profit, cut loss, or add to position based on the strength of the trend:
#3 Use seasonal trends to complement your trading
The final way most traders can use the concept of seasonality is to complement their existing trading style.
For instance, traders that predominantly rely on technical analysis can use the knowledge of seasonality to avoid trading against the seasonal trend, unless there is a fundamental shift in seasonality.
In other words, using seasonality as part of a trader's decision-making process.
Verdict: Using seasonal knowledge in a versatile manner to create your personal edge
Regardless of your trading style, I am sure the knowledge of seasonality will be able to help improve your trading in one way or another.
I hope you like this post, and consider checking out the blog of this site for more useful content!
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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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