TOP FARMER WEEKLY PERSPECTIVE 7/15/2022 BY BRYAN DOHERTY
The Case for Using Stop Orders
Stop orders are used to enter or exit the futures market and can be used for different reasons. Farmers can use stop orders to hedge the crops they intend to grow and may not want to forward contract. Farmers who buy commodities (think of a dairy producer) may use stop orders to offset upside price risk of corn or other key feed ingredients. The recent sell-off in the grain and soybean markets is an example where, in a short period of time (weeks), the price of row crops went from historically high levels to one where prices collapsed, giving up as much as 25% or more of their value. In this situation, a stop order can be useful.
So how does a stop order work? There are two types of stops: sell and buy. Both can be used to enter or exit a market. As an example, a farmer who produces 100,000 bushels of corn annually may like to forward sell to his elevator when a certain price is hit. Let’s say he sells 50,000 bushels for fall delivery. What about the other 50,000 bushels? He doesn’t want to commit to more cash sales. Placing a sell stop with his broker can establish a price floor. A stop order is triggered when the market touches or goes through the stop price. In our case, let’s say the December corn futures is trading at $6.75. The farmer wants prices to go higher. However, he sets his sell stop at $6.65. If prices go higher, his stop is not elected (triggered). If corn futures drop to $6.65, his stop is triggered, and he is a seller. It’s important to note that stops become market orders and are filled immediately at the best price possible. The $6.65 is not a guaranteed price; it is only a trigger price.
A buy stop works the opposite of a sell stop. A buy stop is placed above the current market price and is elected only when the market touches or goes through the stop price. An example is a where a buyer of corn believes the price trend may yet go lower, so he is not purchasing cash corn. However, his stop is in place, should prices rally. The perception of crop size can change in a very short period, especially during key growing months where weather plays a dominant role determining the size of a crop. This can make for fast-moving markets. Should prices work higher, his stop will be elected.
The old saying is “buy low and sell high.” Using stops is not intuitive. Why would someone use a sell stop and sell lower than where the market is currently priced? The answer is that you are not so much concerned with the near-term price trend; rather, the bigger trend and concern that prices could drop a long way. As an example, if a corn farmer this spring wanted to protect the price of corn at $7.00 on December when futures were higher than $7.00, a stop would have been a good way to do this. Once elected, prices were beginning to trend lower. Recently, December corn futures have traded under $6.00.
Using stops is one of many tools in the marketing toolbox that has its place. Only use stops if you have a thorough understanding of how they work and the financial requirements necessary to establish and hold a position. Visit with a professional to see how this tool could work in your operation.
If you have any questions on this Perspective, feel free to contact Bryan Doherty at Total Farm Marketing: 800-334-9779.
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.
Author
Bryan Doherty