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"Systemizing" a Commodity Bet
August 21, 2006
Most of us have had that urge at one point or another — just "knowing" that Crude Oil or Gold is going up or the S&P is in for a down day. These feelings, more often than not, lead to trouble in the form of emotional trading decisions and account losses. But they can just as easily lead to big profits if your "hunch" turns out correctly.
A new client of Attain Capital came to us not long ago wanting nothing else than to be long Crude Oil, thinking it can easily go to over $100 per barrel. While the natural reaction of all those trained in the science of trading systems at Attain was something between - 'that is crazy' and 'it's a huge risk' - we took those feelings a step further by "systemizing" them.
What do we mean by "systemizing"? I'm glad you asked. "Systemizing" a long bet on Crude Oil means nothing more than quantifying and backtesting what that would look like. Seeing exactly what the performance would have been if buying Crude Oil and holding it for years and years.
Many of you are probably asking why this needs to be quantified? Everyone knows Crude is at record highs and has basically doubled in price over the past few years. You don't need a PhD in statistics to figure that one out. It seems on the surface of things that your equity curve would go straight up and you would make a ton of money....but would you ?
The case is not quite as cut and dry as it would seem. For one thing, the price on the news every day is the nominal price of Crude, which is not inflation adjusted. ON an inflation adjusted basis, the price of Crude still remains well below the levels it hit in the 70's during the Oil crisis and inflation spike.
But even if we ignore that fact, there are still many factors which contribute to the profitability of buying and holding Crude Oil futures. Chief among these is that you can not simply buy Crude Oil as you would a stock, and hold it until you're ready to sell. Crude Oil, like all futures - is a contract for a specific delivery date, thus investors must buy Crude Oil futures for delivery at a future date.
The end result of Crude Oil futures having a finite life cycle (the date of their contract expiration) is that a "buy and hold" investor must continuously "roll" her position from contract month to contract month. This keeps the investor from having 1000 barrels of Crude Oil delivered to her house.
The effects of this roll can be quite small or quite large, depending on the current structure of the market. Crude Oil - and several other physical commodity markets - often show a market profile called "backwardation". In simple terms, this means that the current prices are greater than the futures prices on longer term contract months. This is mainly due to the fact that hedgers (oil producers) are naturally long the commodity (do well when the price increases), thus sell the further out contracts to protect their business. Because the hedgers are always selling, this not only drives down far out prices, but speculators demand a premium (lower price) for the risk they take on knowing they are the main ones on the long side.
As an example, the current price of Crude Oil is about $72 per barrel, while the price of December 2012 Crude Oil is approximately $68.50, showing backwardation. In normal backwardation, simply buying and holding a futures contract can earn positive returns as the Spot and Futures price converge at maturity of the contract (assuming the futures price rises to the spot price). For this reason, many long only commodity indexes have large slices of their indexes invested in Crude Oil.
An interesting side note to this discussion is that Crude Oil is currently exhibiting the opposite of "backwardation" in its closest contract months. That is, the price of Crude starting in the next month and going out about one year is more expensive than the current price. That is telling us there are concerns about future supply and perhaps more consumers of oil (think airlines) hedging prices by buying Crude Oil. (Consumers are naturally short Crude, as they do better when prices fall, thus buy Crude to hedge).
One further note -institutional money managers have $100 billion to $120 billion in commodities, at least double the amount three years ago and up from $6 billion in 1999, says Barclays Capital, the securities unit of Barclays PLC. A good portion of this money has headed into long only commodity indices like the Goldman Sachs Commodity Index and others over the past few years.
Is it possible that this sort of 'artificial' buying by the funds that track these indices is throwing the natural equilibrium of the hedgers selling and speculators buying out of whack? Causing unnatural market forces for trend following trading systems and CTAs? And therefore causing the sub-par many trend following systems and CTAs have posted over the last few years?
You bet it's possible - but that's a topic for another newsletter. Let's get back on track with "systemizing" the long Crude Oil trade.
So what does a buy and hold in Crude Oil futures look like? A lot different than the numbers you get on TradeStation or Wealth Lab, unfortunately, which don't take into account the cost and spread of rolling contract to contract.
It isn't enough to simply calculate the percentage return Crude Oil made over the past 10 years and call that your "Buy and Hold" gain. Systemizing means looking at the daily ups and down of that long position, of seeing what the drawdwon was, and finding out how much capital was needed to not be forced out of the position due to margin concerns. And it also includes the effect of rolling the contract over month after month for 10 years.
There are costs involved with the rolling of the contract. There are commissions, but more importantly there is the spread between the further out contact and the expiring contract. These costs must be included in the "systemizing", and indeed we went back and built a trade by trade track record with the "system" rolling it position every month by selling the expiring contract and buying the next contract month.
The table and chart below is what we mean by "systemizing" the long Crude Oil trade. We can now see that it would have been a "hunch" for the ages over the past five years - but not without a great deal of risk in the years prior to that, to the tune of a 97% drawdown (or about $24,250). Where will Crude go from here? No one can know for sure, but it is nice to have a map of sorts to see what the equity curve may look like if Crude continues to ascend as it has the past 10 years.
Want to have Attain follow Crude or any other market SYSTEMATICALLY for your account. Give us a call at 800.311.1145 or email firstname.lastname@example.org for more information. In addition to the logic used in the Crude Tracker below, we have researched long only positions using simple moving average exits and more. Its an easy an efficient way to get the commodity exposure you're portfolio may need.
IMPORTANT RISK DISCLOSURE
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Feature | Week In Review: Swing trader Tzar hitting on all cylinders as Stocks rally. | Chart of the Week
US Stocks bounced back last week as inflation friendly economic numbers pushed SP futures to new monthly highs and across the psychologically important 1300.00 level last week. For the week SP futures were up +2.73% while NASDAQ futures showed even more strength gaining +5.95%. Smallcaps also rallied higher with Russell 2000 futures climbing +4.77% and SP Midcap 400 futures moving +3.45% higher.
The stock market was also buoyed by lower energy prices. Great supply numbers along with a quiet hurricane season thus far have allowed energy futures to fall drastically over the last 2 weeks. Last week Natural Gas futures led the downward charge falling -8.29% while Unleaded Gas futures (-5.41%), Crude Oil futures (-5.12%), and Heating Oil futures (-3.36%) all moved lower as well.
The red hot metals markets also cooled last week due to reports that show inflation is being contained. Gold futures fell -3.52% for the week, while Platinum futures were down -2.46%, and High Grade Copper futures dropped -0.98%. Palladium (+3.72%) and Silver (+1.22%) bucked the downward trend and moved higher for the week.
Bonds and Foreign Currencies were also on the move with 30 year bond futures gaining +1.24% and 10 year note futures climbing +0.75%. Most foreign currencies also moved higher with Eurocurrency gaining +0.77%, the Swiss Franc was up +0.74%, and Japanese Yen move +0.32% higher. The US Dollar Index moved -0.48% lower for the week.
Grain futures also moved lower last week due to higher crop yields across the Midwest. Wheat was down -3.10% for the month, Corn fell -2.48%, and Soybeans were down -1.36%. The tropical futures markets also took a big hit with Sugar futures falling -8.83%, Cotton was down -2.19%, and Coffee moved -1.11% lower. Finally, in the meats Lean Hogs were up +2.83% and Live Cattle was down -1.81%.
It was another uneventful week on Wall Street which made for lackluster trading conditions in the index futures. Foreign stocks, on the other hand, experienced higher volatility last week and systems trading overseas outperformed their U.S. counterparts.
Top performer for the week was Beta V2 Dax which had three trades for profits of +$2,860.07 for the week. All of the systemâ€™s profits were made on Tuesday when the system entered long three contracts and scaled out of each position throughout the session.
Another Eurex day trader, Phi Plus Dax, bounced back last week with profits of +$1,105.49 on winning trades from Monday and Tuesday, while Kappa Dax had two trades for profits of +$1,033.99. Other foreign systems that were profitable include Omega3v1 Dax +$522.94, Epsilon 12/12 Bund +$420.97, Beta v1 Dax +$260.01 and Rayo Plus Dax +$134.77.
Outside of the stock indices - Tanker CL was able to catch the slide in the Crude Oil market last week and made +$1,100 on one short trade from Wednesday. For investors who donâ€™t want to take on the risk of the full-size Crude contract, trading Eminy Crude is an available option at half the point value.
On the losing side last week - BetaCon 4/1 ESX and BetaCon 4/1Dax were the only Eurex systems that came up short with losses of -$132.02 and -$1,145.78, Bounce eRL lost -$203.30 for the week but recovered from a large loss on Monday with a profitable trade on Tuesday, while RC Success eRL had five trades that lost -$238.40.
Along with last weeks solid up trend it is no surprise that swing trading systems excelled. The system of the week goes, once again, to Tzar - which earned +$7,412.50 across its 4 US market portfolio (ES, NQ, eRL, and eMD). The system held long for most of the run up only to reverse its position early Thursday morning. For the year to date Tzar (4 mkt) is up approx. $27,732 inclusive of fees and commissions.
Adaptive US also had an excellent week as it rode the up trend to new equity highs and profits of +$3,900 on the portfolio. Adaptive is a newer system to the market with live results beginning back in February â€“ at this point the program is in full swing and is available both on the US indices and European markets. The results of the US markets can be viewed on our website at: http://www.attainaccess.com/access/display_results.php?id=861.
Other weekly results were as follows: Bounce eRL +$1,800, SeasonalST eRL +$1,750, Axiom eRL +$1,510, Delphi eMD +$938.60, Jaws Narrowneck +$856.25, Mesa Notes +$796.87, SeasonalST ES +757.50, Axiom eMD +$639.90, Delphi eRL +$421.70, Eclipse eRL +$130, SC Trader eRL -$920, Targets eRL -$1,050, Targets eMD -$1,706.04, and Ping Systems -$2,642.50.
Despite the success in the indices and bonds - Forex markets behaved rather erratically resulting in small drawdowns. The results were as follows; Volcano EURJPY -$10, Volcano EUR -$390, SC Forex GBP -$410, Volcano GBP -$770, and Delphi EUR -$1,310.
Short positions are becoming all the rage for commodity traders as downward moves across the grains, tropicals, and energies are allowing many systems to enter profitable short trades.
As we discussed last week, short Sugar positions have become very popular amongst trend following systems, and for good reason as the price of this commodity is down approximately 29% since early July! The open system positions have not changed much from last week, with the following systems holding open trade profits on short sugar trades. Aberration is making +$2358.00 per contract, Trend Simplicity is short for profits of +$3343.60 per contract and Axiom LT is short in the London Sugar contract for open trade profits of +$2685.00 per contract.
Like Sugar, Cotton is another tropical market that has been trending lower of late and systems with short open trades include new system Vivaldi Seasonal Trends which is making +$745.00 per contract and Axiom LT which is making +$3605.00 per contract,
Elsewhere the grain markets have followed suit and are also trending lower as supply continues to outpace demand. A quick look at the markets shows that Wheat futures are down approximately 8% from the beginning of the month while Corn futures are down -7.91%, and Soybean prices have fallen -6.54% over the same time period. Systems with short open positions include Aberration which is making +62.50 per contract in Corn, Andromeda which is also short in Corn for profits of +62.50 per contract and short in Soybeans for profits of +$1725.00 per contract, Axiom LT is short for profits of +$862.50 in Corn, and Trend Simplicity is short in Corn for profits of +$537.50 per contract and Soybeans for profits of +$1125.00 per contract.
Short energy trades have also become popular of late but most extended downward trends have been difficult to sustain in the volatile energy markets. Trend Simplicity was one system that was victimized last week as it went short in Crude Oil and was stopped out for a loss of -$1400.00 per contract. Other systems with short positions include Axiom LT which entered short in Crude Oil today. Axiom LT is also holding long in London Gas Oil for an open trade loss of -$1650.00 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.