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Monday, November 26, 2007

When and why seasonal tendencies may not work ...

Seasonal data is a wonderful indication of future tendencies. When we speak of "Seasonals" we are speaking of the wikipedia definition. That is, "inclination for markets to follow consistent patterns from one year to the next." They can give you exact entrance dates, as well exact exit dates. They can give you a clue as to the strength of a move, and are very reliable. Why do seasonals work? What is the underlying theory that drives seasonal tendencies? Seasonals work because of fundamental reasons. At X time of the year, demand becomes very high for X commodity, and the price rises, or vice versa. One such example is the Soy complex, and is related to a trade that I performed this year. Around July 15th, Soybeans, Soybean Oil, and Soybean Meal typically fall. Sharply, and strongly. So every trader should make use of Seasonal data, and seasonal inclinations. On November 1st, to December 25th, Seasonally speaking, the stock market moves higher. Consumer confidence is higher due to the holidays, and companies are bringing in higher profits due to consumer spending. So seasonals are fantastic tool at your disposal.

Except when they don't work.

Smile

From November 1st to December 25th is one of the most regular, strongest, seasonal tendencies there is in the stock market. But look at the stock market this year. Nada. So . . . what are we saying? Are they worthless? Hit or miss? Is there any way to tell when a seasonal tendency will work, or not work? Some traders try out seasonals, a trade goes completely opposite, and they write them off having no value. Is there a value to seasonal trading?

Yes, there is. But first we have to go back to a very vital question that we examined before. Why do seasonal tendencies work? This will helps us to see when we should pay attention to seasonal data, and when we can dismiss it as being of less importance.

When you look at a Seasonal chart, such as you will find at the Seasonalcharts.com, you are looking at a securities price, averaged out over a number of years. Think about that. That statement gives you the reason why seasonal tendencies may not work this year. It's the very mathematical theory of how averages work, and what a mean average is. In each year, that is not exactly what happened. You are not looking at charts of what occurred each year. You are looking at the mean average of what occurred over 30 years. That's an extremely vital point to keep in mind.

An average, for those of us who forget

1+2+3+4 = 10

The sum total of adding four numbers together, divided by the numbers we used in the set would give us the average. We used four numbers, so we divide 10 / 4. The mean average of that set is 2.5

In order to create a more and more accurate seasonal chart? You need new data. Which means what is occuring this year. And here's a little secret that many people don't know.

Seasonal tendencies change.

There it is. The seasonal tendency that was tried and true 50 years ago? May not even exist any longer. New market forces come into play, which affects supply and demand, and the seasonal tendency may completely reverse from what it used to be. But people 50 years ago did not know that. They could only use the Seasonal data of the years that came before. If they continued to trade such a tendency, they'd lose money year after year, because it takes many accumulated years to compile a mean average seasonal chart. This is a slow process, and why it's hard to note.

So what's the trick? How can we recognize that weakness in Seasonal charts and Seasonal tendencies, but still use the strengths that seasonals give us?

This is the topic I will begin to explore further. But before becoming familiar with any tool that you will use in your trading career, it is vital to understand:

1) The underlying theory of how the tool is constructed.
2) The underlying theory of what the tool measures.
3) The underlying weaknesses that such a theory has.

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