TOP FARMER WEEKLY PERSPECTIVE 4/16/2021 BY BRYAN DOHERTY
Stop and Limit Orders
This week’s Perspective will look at different types of orders that you can utilize using the futures market. Often, farmers will use the futures market in lieu of cash marketing, as they may want the flexibility and liquidity of futures contracts. There is likely only a finite amount of expected production that most feel confident forward selling. Forward contracts establish a legal contract between the seller and a buyer. Cash contracts shift risk and both parties have an obligation to uphold the agreement. Futures, on the other hand, are traded through a licensed commodity broker. While it is possible to turn futures contracts into deliverable contracts, it is estimated that well over 98% of all traded contracts are offset. This means when hedging, you sell futures, and at some point, will buy back this contract before it expires. The gain or loss can be applied to your final cash price when you sell your crop.
Two types of orders that are often used are limit and stop orders. Let’s take the perspective of a producer, that is, someone who has the inventory (or projected inventory) to market. A limit order is an order that sets a limit, or a minimum price, that you are willing to accept as your sell price. A limit order to sell is always placed at or above the current market price. As an example, if December corn futures is trading at 4.85 and you want to sell at 4.95, you would instruct your broker to place a limit order at 4.95. For this order to fill, the futures market must trade at or above 4.95. There is not a guarantee that you will be filled at 4.95 If that is the highest price the market reaches. There could be several other orders ahead of you that may be filled, and perhaps only a limited number of buyers. Limit orders are often referred to as price orders. Both have the same meaning. If you are a buyer of commodities, say, a hog producer who wants to hedge feed, you would place a limit order at or below the current market price.
A stop order, from the perspective of the seller, is placed below the current market price. You can think of a stop as a trigger order. If prices stay above the stop price, the order is not elected. The order is only elected if the market touches or trades through the stop price. Once touched, the stop order becomes a market order and fills at the best price possible. Intuitively, it may not make sense to place a sell stop under the market because you will be selling lower than where the market currently is trading. The old saying is to buy low and sell high. It may feel like you are doing the opposite and selling at lower prices. Yet, stops are often used after prices have rallied, taking the guesswork out of trying to anticipate a top. If the market tips over and begins to move lower, the concept is that you get swept into the lower prices. If the trend remains down, you may be sold in the very upper range of a rally. Trailing stops refers to the practice of moving stops up as the market rallies. As prices hit new high levels, you are moving your stop up higher as well. The goal with trailing stops is to be ready for when prices break, and until they do, you remain unsold.
Many commodity markets have had a strong uptrend this winter. By knowing how to place limit and stop orders, you have confidence to know which order(s) can work best for you. In the busy planting season, it can be challenging to keep an eye on markets and implement strategy when attending to fieldwork. In addition, emotion may get in the way. Doing nothing can only work for so long. Yet, when prices are high and doing nothing is working, complacency tends to create a lack of action. Protecting prices with stops and setting price goals with limit orders are practices to incorporate and tools to add to your marketing toolbox.
Futures trading is not for everyone. The risk of loss in trading is substantial. Therefore, carefully consider whether such trading is suitable for you in light of your financial condition. Past performance is not necessarily indicative of future results.