DTN’s Six Factors Philosophy

Understanding today’s markets often requires covering many topics, including weather, agronomy, politics, trade policy, disease control, international conflict and more. Even then, the latest news reports are often conflicting and can add to the confusion.

USDA reports are also a big part of understanding markets, but not all information is equal and USDA estimates are not always reliable. There is also the risk of USDA making large, unexpected revisions to old data; revisions that can surprise markets and have an impact on prices.

Even if USDA data was more reliable, history shows a low correlation between USDA estimates and changes in the price of corn, for example. The world of market prices is much more complicated than making a few guesses about supply and demand. Markets are people and potential variations are infinitely complex.

If all that weren’t complicated enough, researchers have identified numerous psychological tendencies that prevent us from making good decisions under stress when uncertainty is involved. In the case of markets, uncertainty is always a factor, but often gets ignored.

DTN Six Factors Market Strategies (or Six Factors, for short) is a disciplined approach that allows us to focus on the market’s most important clues and make an unbiased assessment about the kind of market we face and where prices are likely to go. Six Factors does not predict the future (no one can do that), but it is an excellent tool for making risk-management decisions.

The process itself is fairly simple. Each day, DTN monitors the various markets and notes market behavior in light of the six factors. On a daily basis, the market’s overall assessment is not likely to change much; a weekly summary of all six factors is provided, typically late Friday afternoon.

The Recommendations section is where we let readers know when and what specific action we advise. The recommendations are written for a general audience as we are not allowed to advise specific customer situations. Email alerts help notify our readers when changes in recommendations are made.

Depending on the time of year, recommendations can change quickly, or not at all, sometimes for several months. The timing of recommendations is largely governed by the opportunities the market offers. Because DTN’s lead market analyst has no market positions of his own, he is free to recommend only actions believed to be in our customers’ best interests.

DTN’s Six Factors Explained

In no particular order, trend is the first factor and has a practical role. For example, if the popular consensus is bearish but prices are making new highs, that is an important market clue and demands a closer look. Trends that are accompanied by a strong fundamental reason tend to mean more and last longer than those that are not. Trends that contradict market fundamentals tend to be limited.

Noncommercial trader positions are the second factor we watch and tend to be contrarian indicators. Noncommercials are large speculators that usually behave as trend-followers and typically comprise 20% to 30% of open interest. If backed by a strong fundamental reason, their buying or selling activity can have a powerful influence on prices, and their trend-following tendencies are known for taking prices beyond the point of economic equilibrium. Normally, we don’t want to go against an active trend, but we do become wary when noncommercial positions become heavily one-sided.

DTN also tracks commercial positions in CFTC’s Commitments of Traders report and looks at futures spreads for signs of front-month buying or selling. Commercials are DTN’s third market factor and typically account for 30% to 50% of a market’s open interest. Commercial positions tend to be good sources of market insight, especially when it comes to demand. Commercials also tend to follow a disciplined buy-low, sell-high approach. When commercials are net long on the futures board and prices are historically cheap, it is generally a strong sign of economic support in the market.

Depending on the context of a market, both noncommercial and commercial buying can sometimes be detected in the behavior of futures spreads. A spread that shows prices rising in the near month versus a more distant month is a bullish sign of time preference. When this happens during the delivery process, it is typically a strong indication of demand from commercials. Noncommercials tend to avoid the delivery process.

Seasonality is the fourth market factor. In the case of corn and soybeans, seasonality is one of the most underappreciated price influences that has held up for decades. The tendency of prices to be low at harvest time and higher in early summer has powerful reasons behind it.

Price probability is factor number five and is a simple assessment of value. Research shows that corn prices, for example, in the lower fourth of their five-year range have higher odds of trading higher the following year and vice versa. This simple reminder that value matters contradicts more popular fundamental assessments, and like seasonality, is often overlooked.

DTN’s sixth market factor is price volatility, an important source of information in several ways. In DTN’s Six Factors, price volatility measures the range of price swings around a three-month average to give an idea of the noise level in the market. In the case of grains, for example, prices in the summer tend to have wide swings, often influenced by the nervousness of crop conditions among changing weather forecasts. Quiet volatility, on the other hand, tends to be a sign that prices are not facilitating trade and can be an indication that prices are about to make a move in either direction.

Understanding price volatility can also help in the timing of option purchases. Used with trend and seasonality, price volatility is a valuable market tool.

Another factor included in every DTN assessment, which often goes ignored by traditional analysis, is uncertainty. After we consider all the information at our disposal and make our best, unbiased assessment of the six factors, we always need to make space for reminding ourselves about the things we don’t know. Every new season has its share of surprise, and it is important we never get overconfident in any assessment.

Risk management is a complicated subject, but by distilling the market down to its most important parts and viewing those parts through a disciplined process, we have developed a method that gives our customers the tools they need to understand a market and have access to our best, unbiased recommendations.

DTN’s Six Factor Market Strategies incorporates fundamental and technical market information in the process of assessing each market. Production costs, USDA supply and demand estimates and outside market events are all considered and included with the six market clues that we believe are important to every market.