Holiday Volatility in the Grains and the power of the large funds

  • Posted on: December 30, 2009

My earlier post mentioned the gap higher in the March corn. Nature hates a vacuum, so that gap was promptly filled today, as CH spiked down to 406, and then just as quickly punished new shorts and weak longs simultaneously, by quickly snapping back to the 415-416 level. Just one more case study of why this time of the year, trading, in a word, can be treacherous. Thin volume, little follow-through on moves, create a situation where trading can be like putting your hand in a garbage disposal or a blender…If you’re trying to grab the gold in the bottom, your timing has to be perfect, or you will be donating some skin.

Since very few of us are perfect, and these markets are so choppy, with daily ranges of ten to twenty cents, trade selection has to be 1) pre-meditated, and 2) exit strategies have to be pre-meditated as well.
The problem with these markets from a trader’s standpoint, is that the computer programs add to volatility just enough to stop out longs and shorts alike…punishing all but the most disciplined and patient traders.

The stop worms, as I like to call them, are algorithms which are designed to examine a trading range, calculate a statistical probability where your average human trader would place stops. Those worms then go to work searching for those stops. The idea, is that the computer’s skim the cream off of the market by hitting these stops, and as soon as the stops are triggered, then the market resumes its general trend.
This gives us a situation where in the past we might have had a 4 to 6 cents window of heat for a stop. Now the computers have pushed that window to 8 to 12 cents of heat. Since these computer traders are usually very well capitalized and in many instances are programmed to take 50 to 70 cents of heat, it becomes a game of deeper pockets.

Something to keep in mind while picking entry and exit points for your trades in the grains. In many cases, the intra day moves are exaggerated by the trading moves of these large speculative funds. They are the great white sharks lurking in the water. At times great whites have even been known to attack whales if the situation is right. The key is to acknowledge their presence and go about your business of trading, respecting the ability they have to create short term action when they decide to do something.

No one, over a long period of time can really control the market. But a large fund or large trader can push the market for a bit. Usually just enough to go fishing for stops.

Several years ago I read a story about the head copper trader for China. He had decided that since China was the single largest player in the copper market, and since he did the trading for China, that his opinion that copper should not rise above a certain level was an opinion that he could enforce, simply by selling more and more copper. After about 6 months of the market moving in his face, and after countless millions of losses, that head trader went on a vacation and was never heard from again. He thought he was bigger than the market, and since he had the central bank of China as his backer, he thought he could use it to bludgeon the market into submission.

If that guy couldn’t push the markets long term, then that should be lesson enough that no one can do it. Period.

However, a large fund or a large speculative trader can push the market around for either several minutes or even several days… but eventually, no matter how much dough they have, if they are wrong, they will have to pay up, and get out of their losers.

Interestingly, if they have enough of the open interest, the very act of them puking their position will add to their losses. For instance, as China rolled out of that trader’s losing massive short position, the very act of them buying back thousands of contracts fueled a rally. Every time they bought a chunk back, it raised the prices they would have to pay for the next chunk.

A classic short covering squeeze. Look at the bottom of the page of this blog. There is a long term chart of Silver. Go back and look at the spike in 1980. That was the Hunt brother’s debacle, where they were massive longs. When they had to pull the trigger and puke their losing longs, the resulting down move was…. to put it lightly…. spectacular.

So, as we enter the first of the year and we are anticipating fund buying, just remember, they can push it for a bit, but if they are wrong on the overall direction of the market, they too will have to get out of their losers.

Good Trading.