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  • Speculative strategies

     
     

    The market trend

    Speculators normally follow the market trend. In a bearish market - marked by declining prices - speculators are usually reluctant to enter long. Such a measure would be justified only if the speculator was attempting to buy at a minimum price before a new upward trend occurred. Speculators will sell in a bullish market - marked by rising prices - only if prices are believed to have peaked and a new downward trend is imminent.

    The practice of attempting to buy when prices have sunk to their lowest point and sell when prices are at their highest is risky and difficult. Often luck, rather than skill, is responsible for success in such endeavours. As a rule, speculators try to forecast the market trend and take a position when they reach a conclusion about market prospects. If a market shows a distinct bullish trend, the price rise has already started and it is too late to buy at the lowest price level. Speculators will liquidate their position only when the market has reached its highest level and has begun to fall.

    Stop-loss order

    Just as margin calls protect the clearing house from overexposure to the risk of financial losses, stop-loss orders offer protection to the speculator. Although they are willing to bear some losses from an adverse movement of prices, speculators cannot risk seeing a large proportion of the value of their assets wiped out. Speculators give a stop-loss order in order to moderate their losses. This order is triggered once the price of the stop is reached, at which time the broker seeks to trade at the price given in the order or as close as possible if the market permits the order to be executed. Since the object of the stop-loss order is to get out of a position, such orders have to be carried out ruthlessly. Stop-loss instructions are given the moment a trading position is taken, or sometimes even before, so the taking of any position automatically puts them in place. It is also quite customary to employ a trailing stop. For example, if the initial position taken is good and the market trend continues as expected, the stop can be moved accordingly and so trail the trend, thereby locking in increasing amounts of profit.

    There are several aspects worth considering: first, the position to be adopted (long or short) as suggested by the market analysis, and the size of the transaction; second, the financial resources available for the operation; third, the target profit expressed in points; fourth, the loss, also expressed in points, that the speculator is prepared to absorb if the market moves in an unexpected direction; and finally, the changes in the level of the stop-loss orders that will ensure a paper profit.

    It is important for speculators to decide the maximum loss they are willing to bear before taking a position. Once a position begins to lose points, there is a strong temptation to justify the losses and continue to invest, rather than to accept that the original decision was a mistake.

    Likewise, speculators should define the expected profit (in points) and only liquidate their position when the target has been reached. It is just as common to attempt to take the profits before the positions have reached the maximum level as it is to continue to sustain losses even after prices have sunk below reasonable levels.

    Pyramiding

    When speculators use the profits from their existing futures position as margin deposits to increase the size of their position, they are said to be pyramiding. This type of operation is extremely speculative and plays no role in the normal daily business of coffee producers and exporters. It is not, therefore, discussed here.

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