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Managed Forex trading still the unchartered territory of alternative investments?
October 12, 2009
Every day we see ads online, on TV, and in news publications promoting FOREX the world’s most liquid and most actively traded markets. FOREX or foreign exchange currency trading is the largest single trading arena in the world with approximately $3 trillion dollars changing hands each day. Considering the amount of money exchanging hands it is easy to see why investors become curious about Forex and wonder what exactly it is that they are missing out on.
The most appealing aspects to Spot (cash) FX trading is the ease of market access, along with 24 hour trading and of course leverage. Spot Forex accounts can be opened with as little as $500 and although the days of opening an account with a credit card might have passed us by, it is still absurdly easy to get setup and begin trading an online FX account. There are a plethora of online firms willing to take your money and a quick Google search of Forex trading will pull up a list of the who’s who in online trading. The 24 hour marketplace is also popular because it allows traders to trade when they need too, or when they have time, not the other way around. Finally, there is the leverage factor where a very little amount of money allows the trader to control a substantially larger piece of the market. Most online FX firms allow traders to leverage their accounts at 100 to 1. This means that you can trade $10,000 worth of currency for just a $100 (definitely NOT a recommended practice for anyone attempting to manage risk).
Investors can also get involved in currency trading by trading cash forward contracts and the futures markets. Cash forward transactions are an agreement between two parties to buy or sell a currency in the future at a certain price that is agreed upon at the beginning of trade. This type of trading is usually reserved for larger market players like CTA’s, hedge funds, and institutional banks. Finally, there are the standard exchange traded futures contracts that have been traded at the Chicago Mercantile Exchange since 1972. The advantage to exchange traded futures is that there is virtually no counterparty risk when trading as all transactions are guaranteed by the exchange. This is not the case in online Spot Forex trading. Futures contracts are traded actively by retail investors, CTA’s, and institutional investors.
However, despite the unbelievable growth of the Spot FX marketplace there still seem to be relatively few viable managed investment options for individual investors. Over the past five years we have looked high and low for viable Forex programs to offer to clients. We have interviewed and put money with seasoned traders from large investment banks and pension funds, as well as traders that had success in commodities or stocks, and even some businessman turned traders who cut their teeth hedging foreign currency exposure for large corporations. At the end of the day none of the managers who we have seriously interviewed and/or put money with have been successful. So, why despite all the hype and the trillions of dollars traded each day, is successful Managed FX trading still the unchartered territory of alternative investments?
There are a few factors at play behind the scenes that have not allowed Managed Forex to capitalize on the momentum generated by those involved in the institutional and retail sides of the foreign exchange industry. First, and perhaps the biggest issue, is the lack of segregated accounts available to US investors investing in Spot FX. Most managers trade in the Spot market as they are attracted to the tight spreads and deep market liquidity available on many Forex platforms. And while these platforms do provide for a better marketplace (especially in the middle of night) than exchange traded futures they also do not come with assurance that your funds will be segregated from the operating expenses of the overall firm. This means that your funds can be used to pay creditors during a bankruptcy or institutional failure situation. This situation actually occurred a few years ago with REFCO FX (see October 2005 newsletter: http://www.attaincapital.com/managed_futures_newsletter/77) as clients saw their accounts frozen while the remnants of Refco Holdings made their way through bankruptcy court. Accounts trading exchange traded futures differ, with investor cash held in segregated accounts providing additional protection.
According to David Seibel who is President of Aurora Futures Corp. “The addition of segregated accounts would be the single biggest improvement to the Forex industry that could help managed programs.” David goes on to say that “I have been involved in the FX markets for the past 25 years. I've worked on the corporate side developing hedging programs and as a CTA. The one thing that always strikes me is that the Forex market scares most people. They don't understand it and are generally afraid to try. I have been in conversations with many professional traders that wince at the very mention of FX. Also, many people think Forex is like the Wild West. Until the perception of the market changes it will be a difficult sell.”
The second hidden factor is that Spot FX is an interbank marketplace, which means that all trades/transactions are done directly between the banks and not on a central exchange like the Chicago Mercantile Exchange (www.cmegroup.com) or EUREX (www.eurexchange.co). The lack of an exchange or middle man means that there is nobody to guarantee the trade and “giving up” trades becomes very difficult. Giving up trades is a staple of the futures industry that allows a trader to execute a trade with one clearing firm and “give it up” to or send it to a client at another firm. So, for example, a manager can execute futures contracts for clients at Prudential and have the trades hit at an account at Fortis, PFG, R.J O’Brien, etc. (for a small charge). The reason this can occur is because there is an exchange present to guarantee the credit worthiness of both clearing firms and to allow the trade to be passed through to the other side.
In Forex trading there is not a central exchange and the practice of “giving up” trades is almost non-existent. At the very least it requires a very large credit line through an institutional bank. Therefore, in order to expand their business and trade for clients across multiple firms, Spot FX managers are required to setup an entirely new trading agreement and platform at each firm they do business with. In theory trading on multiple platforms is really not that a big of an issue as long as the manager has the technology and/or people to manage it. However, we have found that this is rarely the case and when a Spot Forex manager expands operations to other firms it often times comes at the cost of client performance. We have seen cases where a manager is profitable at one firm, while losing money at another. Additional factors including account size (a larger account might receive more favorable fills because of the sheer size of the trade being executed…in FX “size matters”) and technology can play a role in trade execution.
No one ever said that investing was easy, but in the case of Managed Forex the above highlights yet another level of difficulty…How are investors supposed to determine the extent to which the above outside operational and logistical factors may have a positive or negative effect on their investment? While there is nothing straight forward about it, if you have active funds in Managed FX or are thinking of making an investment one quick piece of advice, if we may, is to make sure to request actual statements from an existing client ON THE PLATFORM or at the broker you are considering opening an account with. So, if you are opening an account with a manager who executes with FXCM ask to see performance of accounts at FXCM. Don’t allow the manager to refer to statements from another firm.
Will Managed Forex Investment Opportunities Improve?
Regulators are often criticized for misunderstanding and over regulating financial markets – in the case of Forex, we are very encouraged by the amount of effort regulators are putting into improving the potential viability of the Forex market. Beginning last year (October 31, 2008), the CFTC’s (Commodity Futures Trading Commission) made their first attempt to reduce the number of “fly by night” FX dealers (i.e start up FX dealers who allow investors access to FX markets) by raising the minimum firm capital requirement from $5 Million to $10 Million. They also set a schedule which increased the requirement to $15 million by January 17, 2009 and again to $20 Million back on May 16, 2009 (http://www.nfa.futures.org/news/newsNotice.asp?ArticleID=2198).
In addition to the above regulatory changes, effective November 30, 2008 it was determined by the CFTC that any NFA Member who actively manages Forex accounts on behalf of customers is required to provide prospective clients with a disclosure document that has been filed with the NFA prior to use (http://www.nfa.futures.org/news/newsNotice.asp?ArticleID=2191). While this does not apply to everyone managing Forex around the world this is music to our ears!! By researching registered managers ONLY, investors will have the ability to review each manager’s record with the NFA and come to expect a more standardized prospectus or disclosure document. While the NFA does not confirm the actual results published by any advisor the fact that they are required to have formal documentation is a huge improvement. Bottom line double check the registration status of any manager you are considering…if they are not registered we do NOT recommend continuing the conversation or research.
Do Investors Really need to trade Spot FX?
With all the above extra risks associated with Forex trading, we could also argue that having a manager dedicated to trading FX is probably not necessary for most investor portfolios. First, most Commodity Trading Advisors (CTA’s) (especially trend followers and short term momentum traders) already have exposure to the major currency pairs and will trade foreign currencies as conditions warrant. In other words, by selecting mangers that track the currency markets as a portion of their overall strategy you will have currency exposure only when conditions are appropriate for your advisors methodology. For more on this please refer to our newsletter from last week: http://www.attaincapital.com/managed_futures_newsletter/354 .
For those investors saying, “I need the Spot Forex market to hedge my currency risk” – please note that it is worth acknowledging that Attain clients are free to hold any portion of their account funds in the major foreign currencies like the Euro, Aussie Dollar, Japanese Yen, Canadian Dollar, and Swiss Franc in their futures account. Additionally, if appropriate, investors can use exchange traded futures to hedge their dollar exposure if they so choose.
The most important point to take away from the above is not one of mistrust, but rather we’d ask inventors to understand Managed FX is a new and growing marketplace where there is a need to improve the basic level of due diligence. If you don’t already know the NFA link for tracking the registration status of the manager you are researching, here it is again http://www.nfa.futures.org/basicnet/. While this seems like a simple task, we’ve found that using registration status as your initial filter will eliminate nearly ½ of all potential managers from your list. If after this point, you are still curious give us a call or send us an e-mail to email@example.com and we’d be happy to look into the manager in more detail.
Looking ahead, we expect the next 12-36 months to see even greater advancements within the Managed Forex space. Our challenge will be to continue to interview managers and research managed products in hopes of finding talented FX mangers to add to our stable of alternative investment products…Who knows, one day we might actually see US segregated accounts and exchange traded Forex contracts allowing for ease of allocation across multiple client accounts.
IMPORTANT RISK DISCLOSURE
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Feature | Week In Review: Commodity market trends lead to Multi Market managers having strong start to October
Most sectors of commodity and index futures experienced another round of price appreciation as supportive economic signs domestically and abroad led to more risk capital heading into derivative investments. The main catalyst of the rally in most sectors was news that the Australian central bank increased leading rates which was a surprise and caught the marketplace off guard. The early Q3 earnings were also a supporting factor as some companies showed better than expected results. The favorable news was backed up by comments from Federal Reserve Chairman Bernanke that banking conditions were improving enough to consider winding down recent stimulus measures. Asian news continued to bring a harbinger of support as China indicated economic growth still had strong momentum despite weaker export demand from foreign interest hurt by the recent credit meltdown. The lineup for economic reports this week is fairly light with the headliner being the release of the CPI with a few Industrial numbers mixed in. Stock Index futures were again active posting their best weekly performance since July. Small Caps led the strong rally with Russell 2000 futures +5.81% and Mid-Cap 400 futures +5.77%. The S&P 500 futures+4.54% led the larger caps followed by Dow futures +3.94% and the tech heavy NASDAQ futures +3.81%.
The metals complex was back in rally mode as investors remained fixated on the precious metals as an inflation hedge. The increase in Australian interest rates seemed to spark investor ideas that stronger growth could be nearing. Silver +9.00% led the way followed by Palladium +8.10%, Copper +5.84%, Gold +4.41% and Platinum +4.07%.
Commodity and Food sectors posted strong rallies in most sectors as growth figures and weather worries sparked investor interest. Weather concerns and the release of the monthly USDA supply/demand reports were the main market moving factors for grains. The Corn +8.64% was led higher USDA numbers and lingering concerns of cooler weather given that the crop remains behind the usual growth stages which also helped Soybeans +8.93% and Wheat 6.07%. The livestock arena posted advances as higher cash and product prices set the stage with Lean hogs +8.69% and Live Cattle +1.13%. The Soft arena was also firm with support stemming from stronger economic growth ideas and supply concerns. OJ +16.27% led the way followed by Cocoa +8.06%, Coffee +4.59% and Cotton +3.89%. Sugar -10.68% remained in a corrective phase after recent strong price increases.
Price activity in the Energy complex was firm in most cases as seasonal support from stocks building by retailers heading into the winter months and stronger than expected world economic news were the main features. For the week Heating Oil +3.42% led the way followed by Crude Oil +3.00%, RBOB Gasoline +1.97% and Natural Gas futures +1.27%
Currency activity during the past week was mixed as traders continued to pressure the U.S. Dollar Index -0.76% on ideas of a better economic outlook on the horizon. The U.S. dollar was also under pressure on an interest rate increase in Australia which also hampered activity in the British Pound -0.61% and Japanese Yen -0.05%. The Euro +0.99% and Swiss Franc +0.32% were the safe haven currencies for the week. The rate sector was under pressure, especially late week after news of a poor 30-year bond auction with 30-year Bond futures ending -2.28% followed by 10-year Note futures -0.82%.
Multi Market managers have had a strong start to October. Trends in currencies, metals, and stock indexes have provided ample trade opportunities for trend followers and short term momentum traders. The Futures Truth SAM 101 program is the top performer thus far at approximately +4.98% for the month. The Futures Truth MS4 program has also had a good start to the month at +1.33% est.
Other top performing programs include the Attain Portfolio Advisors Modified program at +4.24% est. for the month. Hopefully the early returns are a sign of things to come for the rest of the month as APA has struggled throughout 2009. The APA Strategic Diversification program has also started strong at +1.72% est. this month. Dominion Capital Management Sapphire continues to trade well at +1.33 est. Other managers in the black include Quantum Leap Capital Management +0.67% est., Robinson Langley +0.29% est., GT Capital +0.28% est., and Sequential Capital Management +0.19% est.
Managers who have started October in the red include Mesirow Financial Commodities Low Volatility -0.06% est., Mesirow Financial Commodities Absolute Return -0.21% est., Lone Wolf Investments LLC Diversified -0.29% est., Integrated Managed Futures Global Concentrated -0.37% est., Dighton USA Aggressive Futures Trading -0.53% est., Hoffman Asset -1.49% est., Clarke Global Magnum -8.01% est., and Clarke Global Basic -13.75% est. DMH has not traded this month and is at breakeven.
Options traders have had a good start to the month as well. The top performer so far is FCI OSS program at +2.85% est. for the month. The FCI CPP program has also started October strong ahead +1.61% est. ACE SIPC is up an estimated +1.44% and continues to claw its way out of drawdown. Raithel Investments +0.87% est. and Crescent Bay PSI+0.43% est. have also started strong. Elsewhere, Cervino Diversified Option is down -0.14%, Cervino Diversified 2X -0.79%, HB Capital -0.56% est., and Crescent Bay BVP -1.52% est.
In agricultural and specialty trading Livestock CTA +1.13% est. and Emil Van Essen LLC +0.74% est. are in the black. NDX Abedengo -0.38% est., NDX Shadrach -2.83% est., Oak Investment Group -0.40% est., and Rosetta -2.37% est., have started the month slow.
Finally, short term index trader Paskewitz Asset Management Contrarian 3X Stock Index has started hot ahead +1.69% est.
Stock index futures moved higher last week but a lot of the movement was contained to the overnight sessions. These overnight moves favored the swing trading systems that were positioned correctly but weighed on the day trading systems due to the smaller ranges during the regular sessions.
Starting with the swing trading systems, Strategic SP benefited from the jump in stock index futures over the weekend and continuing on into the early part of the week with a closed out trade for +$7,650. Sister system Strategic ES followed a similar path on the smaller-sized Emini contract for +$1,307.50. AG Mechwarrior ES had three trades last week good for +$735. Rounding out the other three winning swing systems was Bounce ERL +$130 on a pair of trades.
On the losing side of the swing systems, Jaws US 60 lost-$155 after the 30 Year Bond market ran out of steam late in the week. Bounce EMD traded twice for a loss of -$-190. Waugh ES Swing and Ultramini ES ended up with nearly identical results -$680 and -$692.50 respectively each on just one trade. Finally, Bam 90 ES and Polaris finished the week with larger losses of -$1,467.50 and -$1,647.50 respectively. Bam 90 ES entered the week with a bearish position and closed out the trade on Tuesday while Polaris entered short later in the week and only stayed with the position for a day before exiting.
Moving on to the day trading systems, PSI! ERL was the top performer +$370 for the week on a single trade from Monday. Rayo Plus Dax and BetaCon 4/1 ESX were both able to escape the week on a positive note +€160 and +€110 respectively. Day trading systems unable to finish the week higher included UpperHand ES -$30, BounceMOC eRL -$80, Freedom ES -$130, BounceMOC EMD -$-190, Clipper ERL -$240 and ATB TrendyBalance v2 Dax -€2,057.50.
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.