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  • 10.2.1-RISK AND THE RELATION TO TRADE CREDIT-AVOID OVER-TRADING

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  • Avoid over-trading

     
     
    People often associate risk management with price protection but there are many different types of risk and risk management. At a cost, exporters and traders can buy protection against many forms of risk. But there are other risks inherent to the trade in coffee that only they can 'manage'.

    The serious exporter's long-term strategic objective is to trade steadily and profitably, and to seek regularity of business; not to chase potential windfall situations involving speculative moves with the potential to put the day-to-day business at risk. Solid seller-client relationships are founded on confidence and regularity of trade. Regular purchases maintain producer links; regular offers and sales help to convince clients to place at least part of their business 'with us'.

    Purely speculative trading has no place in such a strategy but many an exporter has unwittingly fallen foul of speculative markets. When prices are low, the potential risk of a sudden rise is often high. Conversely, when prices are very high then the potential risk of a sudden fall increases accordingly. This conventional wisdom is reinforced by an old but accurate saying in the coffee trade: 'When prices are down coffee is never cheap enough, yet when prices are on the up then coffee is never too expensive.' In other words, when high prices fall the herd does not buy, yet when low prices rise people buy all the way up and beyond. This often causes either movement to be exaggerated.

    A speculative long position in physicals in expectation of a price rise needs to be financed. If one allows such speculation to take up most available working capital and the market turns - it falls - the competition will be able to buy and offer at the lower levels. The choice is then: sell at a loss, or lose business and perhaps lose buyers as well by letting the competition in. The only consolation, perhaps, is that in theory the loss potential of long position holders is limited to their investment. Those with short positions potentially face an open-ended price risk.

    Selling physicals short in anticipation of price falls usually does not require any direct investment (as opposed to selling on the futures markets where margin payments have to be put up), but the risk is entirely open-ended. Should an unusual event occur, the market may rise beyond all reasonable expectation. In extreme cases it may become impossible to cover the shorts at any price. Because the uncovered sales are showing a serious loss one becomes reluctant to make further sales, even though buyers are now prepared to pay more. This again opens the door to the competition to grab both business and clients. Worse, with higher sales prices more can be bid in the local market thus squeezing the short seller from both sides.

    Quick turn-around? A trader who decides early enough that the market is definitely turning against them can quickly cover their shorts and go long. Or, in the reverse instance, sell stocks and in addition go short. But only if they can finance all these transactions. If they cannot, if they have overextended themselves by over-trading, then the party is over, at least for this season.

    Price protection, hedging, options and other risk management tools may be available in theory. But such instruments will not necessarily save those who overextend themselves and do not manage their physical or position risk.