Commodity Futures Trading Blog

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.

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.

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