Commodity Futures Trading

The Relativity Commodity Futures Trading System

I’d like to thank you for your interest in the Relativity Commodity Futures Trading System. After reviewing the following article, I am sure you will agree that we have created something unique.

Let me start out by introducing myself. My name is Dean Hoffman. I have been in the commodity business for over 23 years, the last 17 of which I have spent researching and developing specialized commodity trading systems.

In 2001, I created a financial software company dedicated to commercial trading systems. One of those systems has done so well that the Futures Truth Company, an independent trading systems evaluator, has decorated us with their prestigious Top Ten Trading Systems of All Time award—not once, but twice.

My experience ranges from running my own futures brokerage firm at the Chicago Mercantile Exchange to my current position as a licensed Commodity Trading Adviser. I am the founder and owner of two successful trading companies, DH Trading Systems and Hoffman Asset Management. Using my proprietary trading systems, I trade around 15 million dollars in the futures markets daily.

It is from these many years of experience that I have refined the ideas that I am about to share with you.

Trading System Basics

In this section, we are going to explore some of the fundamentals of commodity trading. Experienced traders may want to skip ahead to the section on Relativity.

Trends

The first basic concept that needs to be understood is trends. Trends are the basis of all trading profits. Prices must “trend” higher from where a trader bought, or they must “trend” lower from where he sold to make a profit. Some may argue that they are “counter-trend” traders, but even these need a trend in price (no matter how short term) to make a profit.

When you think about it, trends can be seen everywhere. Temperatures gradually trend from warm to cold as winter approaches. The demand for gasoline gradually trends higher during the summer driving months. Ground moisture trends from moist to dry when a drought approaches, and interest rates trend from high to low or low to high over time, and so on.

All these events, whether seemingly natural or unnatural, can create sustained price trends in the futures market, and it is from these trends that we can try to profit. Systems like these are often referred to as “trend following systems.” Calling them “trend following systems” is correct because these systems cannot and do not try to predict trends. Instead, they jump on board with the trends once they have begun, and there are many empirical studies that prove that commodity markets tend to trend well.

The real difference among traders is how they determine the beginning and end of a trend. A trader may define the starting point of a trend as something as basic as a slight change in the direction of a moving average. As an example, some traders might use a rising moving average of prices as a signal that the market is ready to go even higher. Counter-trend traders, on the other hand, might use this same indicator as a symbol that the market is overbought and getting ready to head lower. Both are potentially correct depending on their exits. The real question is how we can quantify these trading approaches and code them into profitable trading systems.

Position Sizing and Money Management

Along with entry and exit methods, a trader must also have an excellent position sizing and money management plan. Even if his entry and exit points are 90% accurate, if a trader risks it all on every trade, at some point the odds are substantially in favor of him losing all his money. By the same token, a system that is only accurate 10% of the time but has proper money management could do well.

The bottom line is that traders need to know precisely how much of their account to put at risk in any given trade. It is also necessary to know how many positions to buy or sell whenever there is a signal. An expert system should provide traders with all this information.

Definition of a System

A system can be defined as a combination of entry and exit techniques with a proper money management plan. Some people are content to trade one system while others may combine many different systems.

Trading Psychology

The final piece of the puzzle is proper trading psychology. It does not matter how brilliant a trader’s systems are, if he is unable to take the heat during the inevitable drawdown periods, he will fail. By the same token, if he gets too ecstatic during winning periods, he will also tend to fail.

The key is emotional consistency and the ability to stick to a system through thick and thin. A trader must have complete confidence in his approach. This is where extensive (and proper) testing can help. Testing can help to build up solid proof that what a trader is doing works over the long run.

Summary

In summary, traders need to have an edge. This edge should consist of:

1. Proven entry and exit techniques 2. A proven position sizing and money management plan 3. Proper trading psychology

Keep in mind that, although it would be easy to expand each one of these three points into a whole book of its own, my purpose here is simply to give traders a high-level overview.

The Relativity Trading System

Now that we have laid the basic groundwork, let’s get into the specifics of the Relativity Trading System.

Relativity is a combination of 5 different trading systems. Trading 5 systems simultaneously will give a trader much greater diversification than trading only one. All these systems are essentially trend followers, yet they also incorporate parts that are more inclined toward counter-trend following. Once again, even this helps add to diversification.

These 5 different systems also communicate with one another and trade together as one integrated unit. For example, if one system has already invested heavily in Japanese Yen, the other four systems know not to take any more trades in that market. Doing so would not help to diversify but only raise the risk in the same trading idea.

The Relativity Trading System uses more than just the basics of price direction as its method to generate signals. Relativity starts by using sophisticated pattern recognition techniques that enable it to more accurately identify the best risk-to-reward entry points. It then uses a series of different exits to limit risk and lock in profits. Many customers find this exit methodology pleasing, the reason being that, unlike many other trend following systems, the Relativity Trading System tends not to give much profit back after a large move in its favor.

Dynamic Portfolio

One unique aspect about the Relativity Trading System is its dynamic portfolio logic. Unlike most systems that predefine a smaller portfolio to trade, Relativity trades almost every commodity market, and it does this while still maintaining low minimum account size requirements.

The reason it can do this is that this systems program ranks nearly all the markets into percentiles on a daily basis. It then narrows its list down to only those few markets that have the highest relative trending potential. The net result of this practice is that, while not many markets may be on its radar at any given time, that small list is constantly changing depending on where the best opportunities lie, and the greatest benefit is that traders do not have to worry that the best trends will occur in markets that they do not trade!

Money Management and Position Sizing

The Relativity Trading System also thoroughly handles position sizing and money management. It specifically manages how many contracts to enter when a trader gets a trading signal. This is essential because different futures contracts have different volatilities and trading them all in equal numbers would not be properly diversifying. If a contract, for example, tends to have high-volatility, a trader should trade fewer of those than another whose volatility is lower. The Relativity Trading System uses a trader’s account size to determine the proper position size for each trade he makes. Frequently the right position size is simply zero, and there are four reasons for this:

First, if the trade occurs in a market that is not strong enough in rank to be in the dynamic portfolio. Second, if, given the account size, the risk in the trade is just too high. Third, if there is already enough or too much risk held in that given sector. And fourth, if there is already enough or too much risk across all the current positions in the portfolio.

Relativity does not try to risk more than 1.5% of a traders account size in any given trade. It will also not risk more than 5% of his account in any given sector. Let’s suppose, for example, that a trader purchases crude oil for his account. If the risk in that trade amounts to 5% or more, Relativity will not take new trades in any markets that are highly correlated such as unleaded gasoline.

Relativity also will not try to risk more than 10% of a trader’s entire account at any given time. Meaning, if every trade a trader is in were to hit its stop price simultaneously, the total should represent no more than about 10% of the entire equity of the trader’s account. Once the risk level either reaches or goes past this 10% level, Relativity will reject all new trades and return a position size of zero.

(* see risk disclosure on limiting risk)

Summary

In summary, the Relativity Trading System combines all the parts that I believe are essential to a trader becoming successful at trading commodities. Relativity diversifies not only across many specific winning systems but also across nearly every commodity market. This, combined with its conservative position sizing and money management, creates a system that should not only meet but far exceed traders’ expectations.

Dean Hoffman DH Trading Systems

IMPORTANT RISK DISCLOSURES

*Risk percentages cannot be guaranteed, occasional market conditions could cause a traders stop loss orders not to be filled at the specified prices

Futures based investments are often complex and can carry the risk of substantial losses. They are intended for sophisticated investors and are not suitable for everyone. The ability to withstand losses and to adhere to a particular trading program in spite of trading losses are material points which can adversely affect investor returns.

Past performance is not necessarily indicative of future results

HYPOTHETICAL PERFORMANCE RESULTS HAVE MANY INHERENT LIMITATIONS, SOME OF WHICH ARE DESCRIBED BELOW. NO REPRESENTATION IS BEING MADE THAT ANY ACCOUNT WILL OR IS LIKELY TO ACHIEVE PROFITS OR LOSSES SIMILAR TO THOSE SHOWN; IN FACT, THERE ARE FREQUENTLY SHARP DIFFERENCES BETWEEN HYPOTHETICAL PERFORMANCE RESULTS AND THE ACTUAL RESULTS SUBSEQUENTLY ACHIEVED BY ANY PARTICULAR TRADING PROGRAM. ONE OF THE LIMITATIONS OF HYPOTHETICAL PERFORMANCE RESULTS IS THAT THEY ARE GENERALLY PREPARED WITH THE BENEFIT OF HINDSIGHT. IN ADDITION, HYPOTHETICAL TRADING DOES NOT INVOLVE FINANCIAL RISK, AND NO HYPOTHETICAL TRADING RECORD CAN COMPLETELY ACCOUNT FOR THE IMPACT OF FINANCIAL RISK OF ACTUAL TRADING. FOR EXAMPLE, THE ABILITY TO WITHSTAND LOSSES OR TO ADHERE TO A PARTICULAR TRADING PROGRAM IN SPITE OF TRADING LOSSES ARE MATERIAL POINTS WHICH CAN ALSO ADVERSELY AFFECT ACTUAL TRADING RESULTS. THERE ARE NUMEROUS OTHER FACTORS RELATED TO THE MARKETS IN GENERAL OR TO THE IMPLEMENTATION OF ANY SPECIFIC TRADING PROGRAM WHICH CANNOT BE FULLY ACCOUNTED FOR IN THE PREPARATION OF HYPOTHETICAL PERFORMANCE RESULTS AND ALL WHICH CAN ADVERSELY AFFECT TRADING RESULTS.

Tags: trading+system,trading+systems

The futures industry’s rules for segregated funds help protect customer capital in the event of a brokerage bankruptcy.

In recent years, many investors found out the hard way they have very little recourse to recover funds in the event of a financial firm’s bankruptcy. Although the Bernie Madoff “hedge fund” was by far the highest profile case, there were numerous less publicized bankruptcies and defaults at other firms and investments (including legitimate ones), in which investors found recouping remaining funds difficult or impossible. Sometimes it’s a case of being the last in line of a long list of creditors, a problem that’s compounded when customer funds aren’t separated from a firm’s funds. Such “commingled” funds might have been used to fund the firm’s operating expenses or in its own trading. If a firm enters bankruptcy, it can be very difficult or impossible to recover customer funds that were commingled in such a fashion.

However, all futures trading accounts, including managed futures, have the advantage of specific industry rules that require the segregation of customer funds from the firm’s own funds. The practice of segregating customer funds protects investors in the event of default at the Futures Clearing Merchant (FCM, the industry term for futures brokerage firms licensed to trade on futures exchanges in the U.S.) holding their account. While FCM bankruptcies are rare, they do occur. In 2005, Refco Inc. and 23 of its unregulated subsidiaries filed for Chapter 11 bankruptcy protection. However, Refco’s regulated subsidiaries (where customers’ futures trading and managed futures accounts resided) were unaffected and customers were able to continue trading and managing their accounts. Investment Risk and Firm Risk

Although first-time managed futures investors might assume they’re depositing money directly with the commodity trading advisor (CTA) running the fund, in fact, customers open an account in their own name at an FCM. The CTA is then given the authority to trade per the fund’s investment strategy. Segregated funds possess a separate identity from FCM funds in the firm’s bank account. Once funds are deposited, the bank signs a written acknowledgement stating it will not use the funds for anyone other than the customer. Also, the FCM is required to use these funds only in certain pre-defined instruments. The end result is that, in the event of a crash or FCM bankruptcy, customer funds can be more easily recovered.

FCM Reporting Requirements

Segregated funds are subject to stringent daily, monthly, and annual monitoring by industry regulatory agencies. Every day, FCMs must submit a report to the National Futures Association (NFA) detailing the breakdown of their customer funds. This “Segregated Investment Detail Report” (SIDR) lists the actual and expected segregated funds in the FCM’s accounts. In addition, every FCM must file monthly financial reports with the Commodity Futures Trading Commission’s (CFTC) Division of Clearing and Intermediary Oversight (DCIO) within 17 business days after the end of the month. Finally, the FCM is subject to a yearly audit by the Joint Audit Committee, a consortium of U.S. futures exchanges and regulatory organizations.

CFTC oversight

The provision for segregated funds is stipulated in the Commodities Exchange Act. As a result, the CFTC, which is the futures industry equivalent of the Securities and Exchange Commission (SEC), regulates all practices for segregated funds. Any case of malpractice results in an administrative proceeding before a CFTC law judge. If an FCM is found guilty of the charges, the CFTC can suspend or revoke trading privileges, assess penalties, or issue cease and desist orders. There have actually been very few malpractice cases; most are the result of technical or processing difficulties within an FCM, or a delay in reporting. For example, the CFTC imposed a civil penalty of $300,000 in 2009 on a large FCM for violating rules related to segregation. Besides reporting process violations, the CFTC charged the company with not holding enough funds in its customer funds account. (The shortfall occurred because the FCM had purchased Treasury notes between 2007 and 2009 using a mix of its own and customer funds.) In response to the charge, the firm established a “segregation forecasting mechanism” to ensure that proper segregation was maintained between customer and company accounts. Before making any investment in futures or managed futures, investors should research the company where they plan to open an account. The NFA makes this research easy at the BASIC (Background Affiliation Status Information Center) section of its website.

Dean Hoffman

*Source – CME Group

Managed Futures

Over the last seven years, investment in professionally managed futures accounts has more than quintupled. According to hedge fund tracking firm Barclays, assets under management rose from approximately 41 billion dollars in 2001, to more than 219 billion dollars today! This is a trend that we expect to see continue, not only as the demand for commodities continues to rise on an international level, but also as more investors, individual and institutional, start to see commodities as a sensible investment vehicle.

This steady growth has also raised the need for greater discretion in selecting a Commodity Trading Advisor. In this article, we will outline what we believe are some of the best tools and methods available to the individual investor when choosing a managed futures product.

Managed Futures Defined

Let’s first define what managed futures are and what they are not. Managed futures are not merely stocks or ETFs that invest in commodities. Managed futures accounts are investments in which the funds invest mainly in leveraged, future dated contracts for either commodities or financial instruments. Commodities may include sectors such as food, energy, and raw materials, and financial instruments may include interest rates and stock indexes. The leverage of these investments means that risks and rewards can be, but are not always, substantially higher when investing in futures markets than when investing in the stock market.

The National Futures Association and the Commodity Futures Trading Commission handles regulation of managed futures investments in the United States, unless, the firm or fund has exempt status. Regulated firms hold either a Commodity Trading Advisors license (CTA license) or a Commodity Pool Operators license (CPO license). Keep in mind, however, that just that a firm carries a license is in no way an endorsement of that firm’s future performance. Because futures’ trading has the potential to come with large risks, it is not cut out for just any investor. Investors should be familiar with all the risks involved before investing.

Finding lists of potential managers to sort through can be a fairly easy task for an investor if he knows where to look. Firms such as Barclays Trading Group, Stark Research, Autumn Gold, and Altegris Investments have large databases of manager information available. One resource we personally like can be found at www.autumngold.com. Autumn Gold offers a free summarized online database of over 450 programs. Although their site requires registration, the programs are of excellent quality and may be sorted by a wide range of parameters including minimum account size, funds under management, and various other measurements of performance.

The only problem we see with online databases is that it can become somewhat overwhelming to try to narrow down so many choices. To help simplify the process, in part two of this series we will share what we think are some of the all around best performance metrics.

Dean Hoffman

Commodity trading carries risks and is not suitable for all investors. Past performance is not indicative of future results.

Tags: managed+futures

A Managed Futures Account is a sort of alternative investment. Unlike a fund, managed futures techniques can take both long and short positions in futures contracts and options on futures contracts in the worldwide commodity, Interest rate, equity, and Forex markets. Managed futures are controlled by a licensed Commodity Trading Advisor, or CTA, who are controlled in the U. S. by the commodities trading Commission and the National Futures Association, or NFA. Some are compensated on a performance charge basis, usually 15% to 30 percent of profits. Other CTAs are compensated by charging a per trade cost whenever the account or fund trades. Most CTAs also charge a management charge each year, customarily between 1% to 2% of the account size. Managed futures accounts include, but aren’t restricted to, commodity pools and commodity funds. MFAs could be traded using any number of techniques, the commonest being trend following. Trend following involves purchasing markets that are making new highs and shorting markets that are making new lows.

Differentiations in trend following managers include duration of trend caught ( short term, medium term, long-term ) as well as definition of trend ( i.e. What is regarded as a new high or new low ) and the cash management / risk handling methodologies.

There are more strategies managed futures advisors use, including fundamental strategies, option writing, pattern recognition, arbitrage, and so on. Nevertheless trend following and adaptations of trend following are the paramount system. For the years 1980 to 2010, managed futures, as measured by the CASAM CISDM CTA Equal Weighted Index, had a compound average yearly return of 14.52%, while for U.S. Stocks ( based mostly on the SP five hundred total return index ) the return was 7.04%. Managed futures have traditionally displayed extraordinarily low correlations to conventional investments ,eg stocks and bonds. Following modern portfolio concept, this shortage of link builds the robustness of the portfolio, reducing portfolio volatility and risk, without major negative impacts on return. This dearth of relationship stems from the proven fact that markets have a tendency to “trend” the best during more erratic periods, and periods in which markets decline are the most uncertain. In reality the CISDM CTA Equal Weighted Index has been up twenty-six out of the 32 times the SP 5 hundred has been down five percent or bigger since 1980.

Commodity trading carries risks and is not suitable for all investors. Past performance is not indicative of future results.

Futures trading offers speculators the opportunity to use enormous leverage. For example, a standard size soybean contract is 5000 bushels of soybeans. At $10 a bushel, this represents roughly $50,000 of soybeans, but the margin required to control that contract may only be a few thousand dollars.

So, a movement of just a few percent in price of the underlying commodity could equal hundreds of percent movement in the value of the initial margin deposit. It is this extremely high margin that has led commodity futures trading to having a reputation as being a place for gamblers.

However, despite commodities gambling reputation there’s a perfect economic justification for its existence. Futures trading allows hedgers the opportunity to offset price risk. Hedgers include people such as farmers, food manufacturers, oil refiners or anyone who commercially deals in the physical commodities market. What a hedger can do with commodity futures trading is lock in the price they are able to purchase or sell a commodity for at a future date.

For example, a farmer recognizes that, at current prices, he can make a sizeable profit from his corn crop; but he will not harvest it for another 60 days. His risk is that prices drop between now and crop time. So, he can sell his un-harvested crop today in the commodity futures market at current prices. This way should prices drop he has already locked in his profit.

The speculator, on the other hand, the person that assumed the risk is gambling that prices will go even higher, and he too can potentially make a profit by selling at even higher future prices (or lose money if prices drop). The farmer is happy as he was able to secure his profit, and the speculator is happy as he gets the opportunity to assume the farmers risk with the potential for profit.

Such futures trading leads to price stabilization in the marketplace. Without such risk transference mechanisms in place, consumers would be subjected to wild swings in commodity costs. Imagine if every time a shopper went to the supermarket their bill varied by 20-30 percent for the same groceries! This would also be the situation in countless other industries that use commodities. The bottom line is that regardless of its betting reputation, commodity futures trading serves a vital role in today’s economy.

For more information on our futures trading system Relativity, please contact us.

Commodity trading carries risks and is not suitable for all investors. Past performance is not indicative of future results.

TAGS: Futures Trading

Managed Futures

Over the last seven years, investment in professionally managed futures accounts has more than quintupled. According to hedge fund tracking firm Barclays, assets under management rose from approximately 41 billion dollars in 2001, to more than 219 billion dollars today! This is a trend that we expect to see continue, not only as the demand for commodities continues to rise on an international level, but also as more investors, individual and institutional, start to see commodities as a sensible investment vehicle.

This steady growth has also raised the need for greater discretion in selecting a Commodity Trading Advisor. In this article, we will outline what we believe are some of the best tools and methods available to the individual investor when choosing a managed futures product.

Managed Futures Defined

Let’s first define what managed futures are and what they are not. Managed futures are not merely stocks or ETFs that invest in commodities. Managed futures accounts are investments in which the funds invest mainly in leveraged, future dated contracts for either commodities or financial instruments. Commodities may include sectors such as food, energy, and raw materials, and financial instruments may include interest rates and stock indexes. The leverage of these investments means that risks and rewards can be, but are not always, substantially higher when investing in futures markets than when investing in the stock market.

The National Futures Association and the Commodity Futures Trading Commission handles regulation of managed futures investments in the United States, unless, the firm or fund has exempt status. Regulated firms hold either a Commodity Trading Advisor license (CTA license) or a Commodity Pool Operators license (CPO license). Keep in mind, however, that just that a firm carries a license is in no way an endorsement of that firm’s future performance. Because futures’ trading has the potential to come with large risks, it is not cut out for just any investor. Investors should be familiar with all the risks involved before investing.

Finding lists of potential managers to sort through can be a fairly easy task for an investor if he knows where to look. Firms such as Barclays Trading Group, Stark Research, Autumn Gold, and Altegris Investments have large databases of manager information available. One resource we personally like can be found at www.autumngold.com. Autumn Gold offers a free summarized online database of over 450 programs. Although their site requires registration, the programs are of excellent quality and may be sorted by a wide range of parameters including minimum account size, funds under management, and various other measurements of performance.

The only problem we see with online databases is that it can become somewhat overwhelming to try to narrow down so many choices. To help simplify the process, in part two of this series we will share what we think are some of the all around best performance metrics.

Dean Hoffman

Commodity trading carries risks and is not suitable for all investors. Past performance is not indicative of future results.

Tags: managed+futures

Many individual and institutional investors search for alternative investment opportunities when there’s a disappointing outlook for U.S. Equity markets.

As financiers try to diversify into different asset sectors, mostly hedge funds, many are turning to managed futures as a solution. But instructional material on this alternative investment vehicle is not yet easy to find.

So here we offer a helpful ( kind of due diligence ) primer on the topic, getting investors started with asking the most relevant questions. The term “managed futures” is about a 30-year-old industry made from pro money managers called “Commodity Trading Advisor” ( CTAs ). CTAs must register with the U.S. Government’s Commodity Futures Trading Commission ( CFTC ) before they can offer themselves to the general public as money managers. CTAs also need to go thru an FBI deep background check, and supply comprehensive notification documents ( and independent audits of finance statements each year ), which the National Futures Association ( NFA ), a self-regulatory watchdog organization reviews.

CTAs often manage their customer’s assets employing an exclusive trading program or a discretionary strategy, which will involve going long or short in futures contracts in areas like metals, grains, equity indexes, soft commodities and foreign currency and U.S bond futures. During the past few years, cash invested in managed futures has more than doubled and will likely keep growing in the approaching years if hedge funds returns flatten and stocks underperform.

A key debate for expanding into managed futures is their potential to lower portfolio risk.

Supporting such a discussion are many educational studies of the results of mixing standard asset groups with alternative investments like managed futures. Dr John Lintner of Harvard University is maybe the most cited for his research in this area. Taken like an alternative investment class alone, the managed futures class has produced comparable returns in the decade before 2005. As an example, between 1993 and 2002, managed futures had a compound average yearly return of 6.9%, while for U.S. Stocks ( based mostly on the SP 500 total return index ) the return was 9.3% and 9.5% for U.S. Treasury bonds ( based mainly on the Lehman Bros long term Treasury bond index ). Re risk-adjusted returns, managed futures had the smaller drawdown ( a term CTAs use to refer to the maximum peak-to-valley drop in a shares ‘ performance history ) among the 3 groups between Jan 1980 and May 2003. In this period managed futures had a -15.7% maximum drawdown while the Nasdaq had one of -75% and the SP 500 stock index had one of -44.7%.

A further advantage of managed futures includes cutting risk thru portfolio diversification by negative relationship between asset groups. As an asset sector, managed futures programs are inversely related with bond certificates and stocks. For instance, during times of inflationary pressure, making an investment in managed futures programs that track the metals markets ( like silver and gold ) or foreign currency futures can supply a valuable hedge to the damage such an environment can have on stocks and bonds. To explain, if bonds and stocks underperform because of rising inflation concerns, some managed futures programs might outperform in these same market conditions. So, mixing managed futures with these other asset groups may get the most out of your allocation of investing capital.

Commodity trading carries risks and is not suitable for all investors. Past performance is not indicative of future results.

 

Notionally Funding a Trading Systems or Managed Futures Account

When an investor looks at the performance of various trading systems or managed futures accounts, one of the most significant statistics is what the required minimum account size is. It makes no sense considering trading systems, or managed futures accounts that have $100,000 minimums if the investor only has $50,000 to invest.

However, it is valuable to know that frequently the investor can start with less than the minimum through notional funding. For example, an investor could notionally fund a managed futures account or trading systems account at the $50,000 level but tell the manager to trade at a nominal $100,000 level. In other words, the account will trade as though there were $100,000 in it, even though there is not. The investor is simply making use of added leverage.

In the previous example, this means that the account will be trading at 2-to-1 leverage. Meaning the investors will have gains and losses at twice the level. Had the investor only put up a third of the nominal amount minimum then he would see gains and losses at 3 times the level and so on.

Why those using Trading Systems or Managed Futures Accounts Might Want to Consider Notional Funding

Notional funding can be an efficient use of capital, because frequently a trading system or managed futures account will not come anywhere close to using all the money in the account. For example, in Hoffman Asset Management’s case we have a margin-to-equity ratio of generally less than 10%. What this means is that for every $100,000 invested, generally speaking, we will be using less than $10,000 at any given time for margin. The remaining $90,000 sits on the sidelines stagnant. Although it is true that interest on those unused funds can be earned, most investor’s feel they could do better investing those funds elsewhere. Often time’s high net worth individuals or institutions will even put NOTHING in their accounts and trade 100% notionally. The question for investors should be “how can I calculate a reasonable notional level to invest at”.

We feel the answer to that question is one that can be computed based on several statistics. Specifically, what is the maximum drawdown expected and what is the maximum margin that might be needed. For example, Hoffman Asset Management (as of this writing) has had a maximum drawdown of about 17% on a $125,000 nominal account size. This means a $21,250 drawdown in cash terms. The maximum margin usage is about 15% on $125,000 or, about $18,750 in cash terms.

To compute a notional investment amount, we suggest that an investor add the maximum expected drawdown and the maximum expected margin usage. This figure would give the investor the absolute minimum they could invest in the account without having a margin call.

In the previous example, if an investor had started on the worst possible day, and had a $21,250 drawdown, and simultaneously had the maximum margin usage of $18,750, he would have needed a $40,000 of cash in the account to fund that $125,000 nominal account size. Once again, some institutions and individuals who are not worried about margin calls may even decide to fund the account with less than that (or zero).

Benefits of Notional Funding to the Trading Systems or Managed Futures Account Investor

This allows for the smaller, but more aggressive investor to participate in the program without needing to tie up the entire amount in cash. This will amplify their gains and losses at the added leverage level they are using. If, for example, the manager made a 30% return with a 17% drawdown, then the investor at 2-to-1 leverage would have experienced 60% gains with a 34% drawdown.

Once again, this is a more aggressive approach, and we recommend this only for investors who fully understand the benefits and risks of notional funding, but for the right investor, this can be a valuable tool to have in his or her arsenal.

Dean HoffmanHoffman Asset Management

Commodity trading carries significant risks and is not suitable for all investors. Past results are not necessarily indicative of future results

TAGS: Managed Futures Accounts, Managed Futures Account, managed futures

With computers as powerful as they are today, it is easy optimize a trading system to make it look exceptional, but an optimized system is not always a reliable one. Just because a trader can program a computer to have 20/20 hindsight does not mean that the programs future performance will be anything like its past.

The primary problem with optimizing a computer’s past performance is that all markets change. A low-volatility market may become a high-volatility market. A market that is prone to trends may become choppy and directionless, and a market that previously had high leverage can change into a market with low leverage. What tends to happen is that oddly enough, market X will tend to start acting like market Y, and market Y will start to act like market Z. If a trader has thoroughly optimized his system to trade market X, he will be in trouble when it starts to trade like market Y.

This is a common problem with many trading systems, especially stock index trading system that tend to be optimized to only one market. Despite the occasionally impressive looking results of these trading systems, there is a poisonous strain in their mix. Now contrast the previous scenario with one in which the trading systems design works well with almost all the markets, A through Z. In this case it does not matter if market Z starts to act like market Y, or if market A starts to act like market P The markets can change as many times as they please and it will not affect performance because the trading systems design is universally robust and it can deal with nearly ALL the various types of markets. Once again, even if the characteristics of the market reshuffle countless times, the system acts as a Swiss army knife easily dealing with any scenario.

Good trading systems are universally robust. As markets and conditions change, these systems are able to deal with the various types of changing market characteristics.

Commodity trading carries risks and is not suitable for all investors. Past performance is not indicative of future performance.

 

A Managed Futures Account is a sort of alternative investment. Unlike a fund, managed futures techniques can take both long and short positions in futures contracts and options on futures contracts in the worldwide commodity, Interest rate, equity, and Forex markets. Managed futures are controlled by a licensed Commodity Trading Advisor, or CTA, who are controlled in the U. S. by the commodities trading Commission and the National Futures Association, or NFA. Some are compensated on a performance charge basis, usually 15% to 30 percent of profits. Other CTAs are compensated by charging a per trade cost whenever the account or fund trades. Most CTAs also charge a management charge each year, customarily between 1% to 2% of the account size. Managed futures accounts include, but aren’t restricted to, commodity pools and commodity funds. MFAs could be traded using any number of techniques, the commonest being trend following. Trend following involves purchasing markets that are making new highs and shorting markets that are making new lows.

Differentiations in trend following managers include duration of trend caught ( short term, medium term, long-term ) as well as definition of trend ( i.e. What is regarded as a new high or new low ) and the cash management / risk handling methodologies.

There are more strategies managed futures advisors use, including fundamental strategies, option writing, pattern recognition, arbitrage, and so on. Nevertheless trend following and adaptations of trend following are the paramount system. For the years 1980 to 2010, managed futures, as measured by the CASAM CISDM CTA Equal Weighted Index, had a compound average yearly return of 14.52%, while for U.S. Stocks ( based mostly on the SP five hundred total return index ) the return was 7.04%. Managed futures have traditionally displayed extraordinarily low correlations to conventional investments ,eg stocks and bonds. Following modern portfolio concept, this shortage of link builds the robustness of the portfolio, reducing portfolio volatility and risk, without major negative impacts on return. This dearth of relationship stems from the proven fact that markets have a tendency to “trend” the best during more erratic periods, and periods in which markets decline are the most uncertain. In reality the CISDM CTA Equal Weighted Index has been up twenty-six out of the 32 times the SP 5 hundred has been down five percent or bigger since 1980.

Commodity trading carries risks and is not suitable for all investors. Past performance is not indicative of future results.

To the new futures trading system developer one of the most exciting things to play with is optimization. Optimization is using the power of the PC to look at each possible sequence of parameters and rules, and then using only those rules and / or parameters that have worked the very best. With enough PC crunching power, it is possible to find futures trading systems that completely predicted the past! We can run number crunching PC’s on automated routines and have them research many billions of bits of info even while we are sleeping. Many traders do this long enough and later “discover” the holy grail of futures trading systems. They hop straight into the markets with their new super predictive procedures only to find they fall apart in real trading!

What happened? they ask. The answer’s that what they created was likely a commodity trading system that was a statistical coincidence (known as a “curve fit”). Curve fitting is where you force a trading system to conform to historic data. The difficulty is that the markets will behave much differently moving forward; therefore, a “perfect” trading system may be rendered worthless. For example, your computer finds the perfect dates historically to have bought and then sold the market. These dates are likely coincidental and have no future value yet sometimes people will base a commodity trading system on them. This is a clear example; nevertheless most curve fits are some complex form of this basic concept.

Let’s look at another flawed example. Presume we wanted to optimize nickels that were most inclined to land on heads. What we could do is flip millions of nickels and only select those that landed on heads. Then, we can take those remaining nickels and flip them again, once more only choosing the ones that land on heads. We could repeat this process repeatedly, every time only choosing those nickels that land on heads. At about that point, we would conclude that we had narrowed down our nickels to only a tiny handful that were optimized to land on heads. We could then go out and wager large gambles with those nickels putting all our cash on heads. We’d quickly make a fortune, right? WRONG!

We would quickly lose our money. Those nickels were not optimized for heads; they always had 50 / 50 odds. What might have confused some is that they thought they’d found predictable nickels. All they found was a probabilistic coincidence!

As there is so much data, and so much computing power available, these sorts of mistakes find their way into commodity trading systems all of the time. When developing a commodity trading system it is vital to avoid optimizing as much as practical. You need to find NON curve-fit, robust trading systems. There can be a place for some sorts of optimizing, but it must be handled in the right way.

Commodity trading carries risks and is not suitable for all investors. Past performance is not indicative of future results.