What is the seasonal effect
Simply put, the seasonal effect is the tendency for commodity prices and
Open Interest to increase or decrease at certain times of the year.
Markets have a tendency to do the same thing, year after year after year due to planting, harvesting, weather, consumption, and so on. This is what is known as the seasonal nature of the markets; and traders can chart these tendencies and use seasonality as a technical indicator.
Courtney D. Smith wrote in her article Trading Tactics, published by the Chicago Mercantile Exchange in 1986: “Seasonals are very powerful trends. It is not the ultimate trading system, but can be a powerful aid if used wisely.” By the very definition of seasonality, season trend analysis will prove stronger with perishable commodities (like pork bellies) than with storable agricultural commodities (like wheat, corn, oats, soybeans, and coffee); and storable commodities will in turn, exhibit a stronger seasonal bias than metals and financials.
This is not to say that seasonality is absent in many markets. In fact, Lan Turner, president of Gecko Software, maintains that there are seasonalities in all futures contracts. Many contracts are affected by seasonal demand (think heating oil and gasoline) as opposed to seasonal supply (which is often a function of planting and harvesting).
Charting seasonality
A typical seasonal chart will not show individual years. Instead, the seasonal chart will display only January through December on the X axis and % on the Y axis.
In this hypothetical seasonal chart for commodity X, the price tends to fall in the winter, steadily rise during the spring and summer and fall in autumn. The seasonal chart does not show absolute prices but only the average monthly variance from the average annual price.
Technicians will study seasonality to identify repetitive trade set-ups with a high statistical probability. For example, a long position in July soybeans, initiated on February 7th and liquidated on (or about) March 30th, has proven to be a profitable trade for 12 out of the past 15 years (1997-2007). In fact, the average profit from this trade has been $0.50 per bushel (equal to $2500 per contract) whereas the average loss has been only $0.34 (-$1700 per contract).
But traders take caution! Averages are statistics, not actual trades!
In fact, if you had placed this trade every year between 1998-2001 your net loss (before commissions) would have been -$3,862! And while this seasonal trade paid off very well for the years 2002-2007, this year the seasonal trade would have been disastrous.
This demonstrates that seasonal studies are not without exceptions and were never utilized as hold rails of trading. But traders are reminded of Damon Runyon’s observation that “the battle is not always to the strongest nor the race to the swiftest, but that’s the way to bet.”
Larry Schneider is director of marketing and business development for Zaner Group, a futures and forex brokerage firm that offers platforms for self-directed traders and traditional broker-client full service for all futures markets and contracts, worldwide (www.zaner.com). Larry has spent over thirty years in the futures industry and has served on the National Futures Association’s Advisory Committee on Testing and Education since 1976.