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Lessons from a $6 Billion trade loss
September 25, 2006
In the wake of the biggest hedge fund "blow up" since Long Term Capital Management earlier this month, when Greenwhich, Conn. based hedge fund Amaranth lost $6 Billion on massive "LONG AND WRONG" positions in Natural Gas futures, the volatile nature and riskiness of futures markets has been at the forefront of a lot of talk and articles.
When the smoke finally cleared, we learned that the trade gone bad had cost the once successful hedge fund $6 Billion out of the $9 Billion they had started the month with. That represents a loss of approximately 66% in less than a month, and many trading systems and managed futures investors are asking a very important question:
Can a CTA or Trading System investment "Blow Up" like this ?
The first thing many investors want to know is if they will be reading about a "blow up" at Attain Capital or in the Compass system or Zenith CTA program, one day in the paper, and whether such an event could cause sudden and unexpected losses.
The good news for investors in such products is that a similar situation can not happen in a trading system investment, and is not likely to happen in a CTA investment. (Quick reminder: CTA = Commodity Trading Advisor, where a professional advisor has power of attorney and places trades for your account)
Why can such a scenario not happen in trading systems or a CTA?
1. Segregated Funds
We saw what happens when a Clearing Firm blows up last October when one of the world's largest clearing firms, Refco, quickly went bankrupt, but not a single client of Attain's (nor any other futures broker we know of) lost any of their money sitting in segregated futures accounts.
The futures industry is set up to protect the investor in case of a collapse of the clearing firm or broker such as Attain, by requiring the clearing firm to hold customer money in segregated funds. That means the customer's assets are not part of the clearing firm or broker's assets, and therefore can't be put at risk on trades such as Amaranth's fateful long play in Natural Gas futures.
2. Risk per trade
Attain specializes in systematic investments, which risk a very small portion of an investor's overall capital on any one trade, usually between 1% and 10%. The Amaranth hedge fund had over half their capital invested in long Natural gas positions, meaning they were risking 50% of investor's money on possibly the most volatile market the world has ever seen.
3. Letter of Direction
While investor's in a hedge fund give the fund manager full authority to do what they want, trading system investors do pretty much the exact opposite. They sign a letter of direction instructing Attain Capital to trade an exact system on an exact market with an exact quantity (or risk per trade).
That means an investor trading the Spartan ES program won't see long Natural Gas futures in her account, and that the investor instructing Attain to trade just 2 contracts per signal won't see 100 contracts done in the account. The letter of direction insures an investor is getting exactly what she bargained for with her trading system investment.
4. Attain as watchdog
One caveat to the above is that an investor in a CTA program technically does give "full rein" to the professional manager, leaving open the door, theoretically, that a CTA could load up on a single, illiquid position.. However, a CTA advisor is required to stick with the trading program outlined in their disclosure document, and unlike a hedge fund, a CTA can not borrow money and leverage an individual investor's capital.
But most importantly, clients having CTA accounts traded through Attain have an automatic watchdog built in with Attain monitoring client accounts on a daily basis. With Attain's knowledge of each CTAs trading programs, usual positions and risk amounts, any thing out of the ordinary can quickly be reported back to the client. If something strange or outside the program is going on,
5. Individually managed account
Finally - CTA and trading system investments are done in the clients accounts, with clients getting account statements every day. The investor is the final level of protection, being able to see the positions in their account on a daily basis, and being able to ask about positions and numbers of contracts if something seems wrong or worrisome.
- Jeff Eizenberg
IMPORTANT RISK DISCLOSURE
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Stocks pulled back slightly last week despite much lower energy prices and a favorable interest rate decision by the FOMC. SP futures fell -0.47% despite the DJIA flirting with all time highs for most of the week. Most of the downward move in the market was on Friday and was probably caused by profit taking due to the historically high market prices. NASDAQ futures were also weak falling -0.69%, Russell 2000 futures dropped -1.48%, and SP Midcap 400 futures moved -1.27% lower.
To the surprise of many; the energy markets continued their sharp decline last week. Natural Gas futures continue to be the downward leader falling -7.59% last week alone, while Unleaded Gas futures were next in line at -6.59%, Crude Oil futures moved -5.42% lower, and Heating Oil futures dropped -4.45%. All of this comes as good news to consumers who have been battling higher fuel prices for most of the last 2 years.
The metals markets continued their choppy pattern last week, bouncing off recent lows to post gains. Most markets were up with Silver futures climbing +4.00%, High Grade Copper futures were up +3.99%, Gold futures gained +2.13%, and Palladium futures moved +2.18% higher. Platinum futures did not join the party however moving -1.34% lower.
In bond trading the second consecutive pause to interest rate hikes by the FOMC caused treasuries to rally last week. 30 year bonds led the way gaining +1.92% while 10 year notes gained +1.29%. Foreign currencies were also up on the news with Eurocurrency futures gaining +0.93%, Swiss Franc futures gained +1.59% and Japanese Yen futures were up +0.92% last week. Meanwhile, Dollar Index futures fell -0.92%.
Elsewhere in commodity trading Wheat futures were up +6.75%, Corn futures gained +2.94%, Lean Hogs fell -4.96%, Cotton futures dropped -1.94%, and Sugar futures were down -1.43% for the week.
The Eurex systems dominated their U.S. competition last week with the top four spots in terms of profitability. Domestically we saw some increased volatility in stock index futures but there were several sharp reversals that occurred late in the U.S. sessions when foreign systems had already exited their trades.
Phi Plus Dax was the top performer last week with profits of +$1,439.80. The highlight trade for the system came on Tuesday when it entered into two units and profited +$1,576.32. Beta v2 Dax had success on Tuesday and Friday and came out of the week up +$966.65. BetaCon 4/1 ESX had two small winning trades on Wednesday and Friday for a gain of +$54.46. Epsilon 12/12 Bund lost -$225.74 on five trades for the week.
Tanker CL lost -$230 on a short trade from Friday. BetaCon 4/1 Dax lost -$432.37 on a short trade from Wednesday. Omega3 v1 Dax lost -$480.06 on a short trade from Wednesday as well. Rayo Plus Dax had two trades for a loss of -$782.82. Impetus eRL struggled last week with a loss of -$1,233.80. RC Success eRL had four trades for a loss of -$1,528. Finally, Compass SP continued to struggle - with three trades losing a total of -$2,466.68 for the week.
This weekâ€™s top swing trading performer goes to Mesa Notes which earned +$3,325 on the week. Mesa Notes is a program that his been waiting in the wind for any type of reaction to the Fedâ€™s rate halting decisions, and it has paid off - with Mesa Notes now up aprox 19% YTD based on a $30,000 initial investment.
Other strategies that ended the week positive included Tzar 4 markets +$1,167.50, Seasonal ST eRL +$1,050, Seasonal ES +$270, Volcano FX EURJPY +$235, Jaws Narrowneck +$193.75, and Volcano FX EUR +$70.
The following ended the week in red and will look to battle back this week; SC Forex GBP -$140, Delphi EUR -$160, Volcano GBP -$330, Eclipse eRL -$810, Axiom eRL -$890, Delphi eMD -$1,314.70, SC eRL -$1,380, Delphi eRL -$1,431.70, and Axiom eMD -$1,956.90.
Energy prices continue to be the hot topic of conversation on Wall St., the local news, and in your neighborhood as the once mighty energy markets have fallen on hard times. With supplies continuing to outpace consumer demand it is only natural for energy prices to come down much to the chagrin of big producers like Exxon and BP. Last week alone, crude oil futures fell over 4% and are down almost 14% for the month of September!
Needless to say this move has been a trend followerâ€™s dream and there are several systems taking advantage. First, Trend Simplicity has been holding short for nearly 2 months is leading the pack with $11,450 of open trade profits on its short full size crude oil position. Aberration Plus is also enjoying the ride and is holding short in mini crude oil for open trade profits of +$4725.00 per mini contract (mini is worth Â½ of full size). Axiom LT is also enjoying the downward move albeit from overseas as the system is holding short in the London Gas Oil for open trade profits of +$8850.00 per contract.
Sugar prices have also been affected by the energy sell off due to its use in Ethanol production. Sugar prices have been tumbling since mid-summer and were down another -1.43% last week. Once again this has been great for trend followers who for the most part have been holding short. Systems with open short positions include Aberration Plus which is making +$3254.00 per contract and Trend Simplicity which is up +$846.00 per contract.
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IMPORTANT RISK DISCLOSURE
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. The performance data for the various Commodity Trading Advisor ("CTA") and Managed Forex programs listed above are compiled from various sources, including Barclay Hedge, Attain Capital Management, LLC's ("Attain") own estimates of performance based on account managed by advisors on its books, and reports directly from the advisors. These performance figures should not be relied on independent of the individual advisor's disclosure document, which has important information regarding the method of calculation used, whether or not the performance includes proprietary results, and other important footnotes on the advisor's track record.
The dollar based performance data for the various trading systems listed above represent the actual profits and losses achieved on a single contract basis in client accounts, and are inclusive of a $50 per round turn commission ($30 per e-mini contracts). Except where noted, the gains/losses are for closed out trades. The actual percentage gains/losses experienced by investors will vary depending on many factors, including, but not limited to: starting account balances, market behavior, the duration and extent of investor's participation (whether or not all signals are taken) in the specified system and money management techniques. Because of this, actual percentage gains/losses experienced by investors may be materially different than the percentage gains/losses as presented on this website.
Please read carefully the CFTC required disclaimer regarding hypothetical results below.
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.