By Todd Hultman
DTN Analyst
Two weeks ago in this space, I talked about a simple four-week trading rule devised by Richard Donchian decades ago which still shows profitable results in today's corn market. While I received nice feedback from readers, I want to re-emphasize that the point of the article wasn't to convince us all to quit our day jobs and trade for a living, but to take a good, hard look at the way we approach markets. We can learn a lot from the success of a simple system that focuses exclusively on price and performs well over time.
Naturally, some wanted to know if Donchian's method also worked for soybeans and I wanted to make sure that the corn results weren't an isolated fluke, so I fired up the spreadsheet again. Similar to the research for Dec corn, I tested back-adjusted price data for Jan soybeans from 1995 through the first half of 2016, using Donchian's trading rule in 10-day increments, from 10 to 50 days.
If you recall the article from two weeks ago, the original trading rule was that one would go long when a commodity closed at a new high of the past 20 days and stay long until the closing price fell below the low of the past 20 days. The method is always in the market, either long or short, and loses money when prices chop around without really going anywhere.
As surprising as it may still seem, we found that Donchian's original 20-day rule was profitable for Dec corn over the past 21 1/2 years. A 30-day rule worked even better, returning a hypothetical profit of $66,525 per contract on 102 trades, ignoring slippage and commission.
For Jan soybeans, the most profitable result came from following the original 20-day rule, generating a hypothetical gain for one contract of $87,975 from 164 trades or an average of $536 per trade. The 10- and 50-day rules were slightly profitable, but not worth the effort. The 30- and 40-day rules generated similar profits per trade to the 20-day rule, but significantly less total profit as they had fewer trades.
Is there a reason corn did better with the 30-day rule while soybeans favored the 20-day rule? It seems fair to say that the 20-day rule worked better in soybeans because it was the more active market. It is also interesting to note that corn prices chronically under-performed futures price expectations over the past 21 1/2 years while soybeans largely surpassed the expectations of their futures prices.
How do we know that? Because one contract of Dec corn held perpetually long from 1995 until July 1, 2016, (by rolling into the next year's contract at the end of each November) resulted in a hypothetical loss of $1.64 a bushel, excluding slippage and commission. One contract of Jan soybeans held the same way and rolled at the end of each December produced a hypothetical profit of $9.94 a bushel. Thank you, China.
Conceding that we don't know how the next 21 years are going to go, I was encouraged to find that splitting the difference with a 25-day rule showed profitable results for both, corn and soybeans. The 25-day rule generated a hypothetical profit of $45,612 on 124 trades for one contract of Dec corn and a hypothetical profit of $86,350 on 128 trades for one contract of Jan soybeans.
Again, the point is not that we all go out and start trading futures. As I mentioned two weeks ago, trading this way has its ups and downs and many will find it difficult to stay faithful to a system like this in the face of contradicting market opinions.
But I do remain impressed with the lessons that this simple method offers. Sometime in the past decade, the notion of "living in the moment" became popular advice. Like football coaches that are "taking it one game at a time," you now hear all kinds of people trying to live in the moment, from athletes to self-help gurus to survivors of serious illness.
In an odd sort of way, I suspect that the main benefit of Donchian's rule might be that it forces its followers to trade in the present moment. Prices are making new lows? We're going short. New highs? We're going long. There is no time to worry about what the guy on the radio says, what's in the latest USDA report, or numerous worries that may never happen. This method stays focused on price and in that sense, it is completely practical.
For those of us keeping our day jobs and still paying attention to the market's other factors, here are two valuable lessons to consider.
First, most of us would benefit from having a greater respect for the price trend of the market. I often get the sense that there are still many who think fundamental information is all that really matters, but then become overwhelmed by minutiae. Paralysis by analysis is a dangerous affliction.
Second, while other, longer time frames may also be profitable, they are not all created equal. Given the history of corn and beans, the sweet spot of the market's most important time frame seems to be somewhere between 20 and 30 trading days. No one can say what the next 21 1/2 years will hold, but I will be paying extra attention the next time corn or beans make a new 25-day high or low.
Now that we are getting familiar with how Donchian's rules have worked out in the corn and soybeans markets, it's time to see if there are more ways that producers could benefit. In the third episode of this series, we will look at one way Donchian's method could be adapted for hedging purposes which comes with an impressive track record. Stay tuned.
Todd Hultman can be reached at todd.hultman@dtn.com
Follow him on Twitter @ToddHultman1
(CZ/)
© Copyright 2016 DTN/The Progressive Farmer. All rights reserved.