FEAR FACTOR

The Hedger's Mind and a Few Marketing Tips from the School of Hard Knocks

The farmer/producer is a hedger. There are always questions which cause anxiety. Will the market go higher? Will it go lower? Will there be enough income to pay the bills? Will the market come back up? Is the market now in a price freefall? Can I make any more money? Will I produce it? These are the kind of questions that are engendered in the greed, hope and fear cycle that all hedgers go through.

Every producer wants "just a little more" when considering prices. It is the emotion of greed that can cause the hedger to miss pricing opportunities. Waiting for that predicted/targeted price, having the price reach a few cents below the price and holding on to the product can be gut wrenching. Another common scenario is to have the market "blow" through the targeted/predicted price causing confusion about what to do because the hedger wants "just a little more." Information and planning can make the hedger objective about these pricing situations.

Another scenario that most hedgers get into is when prices begin dropping. The thought that the price "will come back," that "it is only a two-day drop" is only from hope and not rational thinking. It is true that there are occasional breaks in a bull market, but each break must be measured by the tools that are available in technical analysis.

If the break is accompanied by declining open interest, there is some liquidation by the bulls in the market. If the break is accompanied by increasing open interest, there is new interest in the market to the bear side. It might be time to sell some product. If the charts show an island reversal, a double top, or a key reversal, it might be prudent to sell some production even if the targeted/predicted price has not been reached. The hedger can also be objective about "hope" if the correct information is used.

The hedger must remember that markets will usually retrace over a period of time. That period of time can only be predicted by charts, either long-term or daily, and the use of retracement calculation, either 38%, 50%, or 62%, using the highs and lows that the hedger chooses. If a contract high was made with a double top in the charts or an island reversal or a key reversal, it will be seldom that the market will reach that price again anytime soon unless there is a complete catastrophe.

The last emotion that must be dealt with in marketing is fear -- fear that the market will keep going lower and lower and lower. This type of fear causes a hedger to lose all perspective of the market and act void of logic. This type of selling is common in the market and will always cause the market to overreact to any kind of news. Price will go below what the true value should be. Most hedgers sell at this point on the charts. The use of the tool of options, reading the charts, and knowing fundamental analysis can counteract this emotion.

Seasonal trend can also help to curb some of these emotions that will hamper action by the hedger. It has been established that the best time to sell feed grains is when it is being planted or around the 4th of July. There is usually a rally for feed grains in the December to March time period. Wheat hedgers need to begin selling when it is planted, some in December and some in February. There is usually a bounce in price from the last of April to the middle of May. Once new crop supplies hit the market, there is considerable selling pressure.

If the producer has some trepidation about how much to hedge, he should begin by calculating the number of bushels on which he is not receiving deficiency payments.* The producer definitely needs price protection on these bushels. If the hedger is intimidated in forward contracting for fear that he night not produce what he has forward contracted, he might forward contract only the amount he has insured. The amount to be hedged could also be directly related to the variable input costs. The hedger may want to guarantee to himself that these costs are covered.

[Editor's note: There have been changes as a result of the 2002 Farm Bill that make some differences in how deficiency payments are applied since this article was written.]

Lastly, if a hedger remembers that the hedge is placed to give price risk to someone else and protect profit, he can rest comfortably. The high in the market might be missed, but so will the low. Never have all of your crop hedged.

Here are some rules learned in the hedging school of hard knocks:

1. Never hedge all of the anticipated production in one act.
2. It can be to your benefit to mix the methods of hedging.
3. Watch the basis levels very closely.
4. Make sure your lender knows what you are doing.
5. Never be afraid to get out of a bad position.
6. Do not stand in the way of a raging bull market or a raging bear market.
7. Take advantage of what the market gives you.
8. Never ask advice from a broker and make an order in the same phone call.
9. Have a plan and work the plan.
10. Never be afraid to get out of a profitable position. You cannot lose if you make a profit.
11. Keep your own record of your positions and trades. This will later become a historical marketing notebook for your farm.
12. Watch for the market to reflect the correct psychological tone after news is given. If it doesn't, act accordingly.
13. Measure all of the risks and rewards for any marketing decision that you make.
14. Follow your own mind.
15. Use market signals. Technical indicators can give you signals of when to start hedging.
16. Become familiar with seasonal trends in the commodity that you produce.
17. Know your cost of production.
18. There is no luck in hedging. There is merely readiness to take action when a profit is offered.
19. This is not a contest for "bragging rights." This is an act done to make the farm more profitable.
20. Look to hit singles and doubles. Home runs don't come very often in hedging production.
21. In using the futures market, it is better to be out wishing to be in, than to be in wishing to be out.
22. Don't be afraid to add to this list.