Fueling market volatility: Bigger players or longer hours?
Historically, the CME Group's doors have been closed when USDA has released key data on crop size and grain stocks. That all changed last year, when USDA bumped its report release times and CME Group shifted its hours.
Now, corn and soybean futures are in play when the federal government releases its crop information. So today, trades can be executed at virtually the exact moment of the slightest shift in market sentiment stemming from a bullish or bearish USDA production, stocks or supply/demand report. Algorithmic trading leverages computer software to execute trading decisions in tiny fractions of a second, an inhuman rate with which no flesh-and-blood trader, broker, or farmer can compete.
In an age when the grain trade is already chock-full of volatility, some say the convergence of federal crop information and active trading only heightens that volatility, making the trade virtually impossible for a traditional broker or farmer to effectively leverage positions. Still others say it's not the expanded trading hours, but the players involved in those longer hours that is pushing the myriad double-digit price moves.
The volatility is still there; in fact, the addition of massive funds make price swings possible today that could never have happened in years past. But intense fluctuations like these happen on a short time frame. They happen more quickly, making it possible for electronic or algorithmic traders to get in, capitalize on their positions, and get out. That doesn't necessarily enflame volatility; in fact, it most often eases it, traders and analysts say.
"I think what's happened is the electronic trading has opened our markets to the world and has kind of smoothed out the trading rather than having these bursts of changes," says broker and analyst Don Roose with U.S. Commodities in West Des Moines, Iowa. "What would have happened before is you'd have Europe trading, China would trade at different hours, and we'd never match up with them. They'd go in one direction, and we'd have to catch up. This has smoothed out."
There's been little evidence since the trading hour-shifting began in May 2012 that it's created a more volatile marketplace. That's mostly because of the amount of time a particular shift or piece of information is traded, says Nathan Kauffman, Omaha Branch executive for the Federal Reserve Bank of Kansas City.
"The brief spikes in volatility due to extended trading hours are likely to pose a challenge for producers whose risk management strategies are affected by intraday price swings. Typically, however, the heightened volatility has not lasted more than 30 to 60 minutes," he says. "Thus, producers whose risk management strategies are not affected by intraday price swings likely will not be affected significantly by extended trading during the release of WASDE reports."
Much of the impression that longer trading hours inflames volatility stems instead from another shift that's taken place leading up to the expansion of trading. The landscape of traders has widened and shifted to include participants who haven't previously been involved.
"Since I've been in the business since the 1970s, the thing that's added to volatility is we've opened trading to big, huge investments and index funds," Roose says. "The volatility to me has come from the huge index funds that kind of steered more that direction -- investment vs. the hedge side of it."
And, those large funds -- or "nonproducers" as Kauffman calls them -- have altogether different trading strategies and outcomes. While farmers trade to meet long-term goals and needs, funds are in it for profit, whether that happens in a few seconds or a few weeks.
"Traders in agricultural commodity markets view volatility differently depending on their objectives. Producers generally dislike uncertainty and often trade on futures markets to mitigate the risk associated with potential changes in prices. If futures markets themselves become excessively risky, however, due to high volatility in the prices of futures contracts, producers may begin to question the use of futures markets to mitigate risk," Kauffman says. "Unlike producers, nonproducers -- traders with no direct involvement in producing or using the underlying commodity -- seek to profit from uncertainty by predicting which direction prices are headed. Volatile futures prices, therefore, present nonproducers with a profit opportunity."
This market speculation is, at the end of the day, what contributes more to trading volatility, not the trade's expanded hours. The expanded hours just provide more time during which prices can fluctuate, sometimes sharply due to volatility driven by both fundamental factors and the entry into the marketplace by funds and other nonproducers.
"With shifting market conditions, intraday price volatility patterns have varied significantly over the past five years. Fluctuations in supply and demand, particularly unexpected forecast adjustments, have partly shaped these differences. Information surprises have typically generated more intraday volatility, but the magnitude of the effect has depended on the time of year in which the information shocks have taken place," Kauffman says. "Although the debate continues about the role and impact of speculation in agricultural commodity markets, one effect of the participation of nonproducers in these markets is positive: at least to some extent, it has helped limit volatility. Nonproducers provide these markets with additional liquidity and depth, which are key factors in helping absorb potential shocks."
So, where does this leave the farmer? The prospect of trading in an environment increasingly paced by funds and other large trading entities leveraging thousands of contracts, thereby manipulating exponentially sharper price shifts, may seem like a losing one, but Roose says it's quite the opposite. Though the funds and large traders have the power to make the market move one direction or another, that doesn't mean farmers can't capitalize on those moves. It just takes a keen eye, a measured approach, and the help of some new tools at their disposal.
"Corn and soybeans can rally tremendously in short order. In the old days, it would take a world of time for moves like these to occur. So, when contracts are extremely stretched out, producers can use them as marketing opportunities. But it can be a double-edged sword," he says. "Producers are moving to more instant communication. But with all of this technology and instant trading, you still have to be a good trader and marketer, and have a good sense of balance, or none of it helps you. It just keeps you up to speed."