Timing a hedge decision : the development of a composite technical indicator for white maize

Abstract

The South African white maize market is considered to be significantly more volatile than any other agricultural product traded on the South African Futures Exchange (SAFEX). This accentuates the need to effectively manage price risk, by means of hedging, to ensure a more profitable and sustainable maize production sector (Geyser, 2013:39; Jordaan, Grové, Jooste, A. & Jooste, Z.G., 2007:320). However, hedging at lower price levels might result in significant variation margins or costly buy–outs in order to fulfil the contract obligations. This challenge is addressed in this study by making use of technical analysis, focusing on the development of a practical and applicable composite technical indicator with the purpose of improving the timing of price risk management decisions identified by individual technical indicators. This may ultimately assist a producer in achieving a higher average hedge level compared to popular individual technical indicators. The process of constructing a composite indicator was commenced by examining the prevailing tendency of the market. By making use of the Directional Movement Index (DMI), as identified in the literature study, the market was found to continually shift between trending prices (prices moving either upwards or downwards) and prices trading sideways. Consequently, implementing only a leading (statistically more suitable for trading markets) or lagging (statistically more suitable for trending markets) technical indicator may generate false sell signals, as demonstrated by the application of these technical indicators in the white maize market. This substantiated the motivation for compiling a composite indicator that takes both leading and lagging indicators into account to more accurately identify hedging opportunities. The composite indicator made use of the Relative Strength Index (RSI) and Stochastic oscillator as leading indicators, and the Exponential Moving Average (EMA) and Moving Average Convergence Divergence (MACD) as lagging indicators. The results validated the applicability of such a composite indicator, as the composite indicator outperformed the individual technical indicators in the white maize market. The composite indicator achieved the highest average hedge level, the lowest average sell signals generated over the entire period, as well as the highest average hedge level as a percentage of the maximum price over the entire period. Hence, the composite indicator recognised hedging opportunities more accurately compared to individual technical indicators, which ultimately led to higher achieved hedging levels.