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System Spotlight: Polaris

June 23, 2008

 

Is it more likely that a stock market crash will happen in October than any other month, merely because of the October 1987 crash? Does the performance in January really dictate how the rest of the year will end up? Those investors using seasonal analysis are apt to believe so, as they believe market fundamentals and investor behavioral patterns tend to repeat themselves over time, resulting in certain market scenarios also repeating. This week’s newsletter is a System Spotlight on seasonal trading system Polaris.

Typically, most investors associate seasonal analysis with commodities such as heating oil and gasoline. Heating Oil, for example, usually increases in price in the winter months as there is more demand from colder weather, and decreases in the summer months as there is less demand.

But, as the developer of this week’s featured system would tell you, seasonal analysis can also be applied to the stock markets as well. Several Wall Street pearls of wisdom have their base in seasonal analysis: the so called “Santa Clause rally”, “January effect”, and “sell in May and go away” all rely on logic which argues that because the markets have, on average, gone a certain direction at certain times in the past, they are more likely to do so in the future.

Who is the Developer?

The developer of Polaris is Robert Steelman, whom many Attain customers know as the developer of the SeasonalST suite of systems. Mr. Steelman’s background is in technology and computers. For more than 10 years Robert also worked as a technical consultant for several well known financial institutions. It was during this experience as a consultant that Robert realized the opportunity for mechanical trading systems, especially those that focus on exploiting seasonal tendencies in the markets.

Robert started taking interest in the stock market in 1994, using his knowledge of technology to pick tech stocks and build a successful portfolio. But as the bottom fell out of the Nasdaq starting in 2000 and took back everything he made and then some, it became clear to Mr. Steelman that a more technical approach was needed.

This realization led to a mechanical system for day-trading highly liquid stocks based on seasonal indicators. With the model working on individual stocks, Mr. Steelman soon started testing these seasonal opportunities on other investment vehicles including Stock Index Futures and Exchange Traded Funds.

Robert believes a big part of his background is the following strategy creation guidelines he has developed over the years, and which are the backbones of the Polaris & SeasonalST systems.

a) Prove the strategy to yourself.
b) Trade only with a proven strategy
c) Calculate proper allocation for your strategy while considering your account capitalization. The market will make sure your limits will be tested as the largest drawdown for a system is always in the future.
d) For every strategy set a timeframe for performance evaluation. This could be weekly, monthly, quarterly, yearly, etc. Plot the equity curve. Stop trading with strategies producing losses in two consecutive periods. Remember to be realistic (1 day or 1 month is most likely too short, 1 year is far, 1 decade is too long)
e) Be very disciplined and continue to trade a system until proper statistical analysis tells you to stop.
f) Be very persistent. Don’t let calculated losses derail the trading plan; as the market will cause even the most confident to question their strategies.
g) Don’t attempt to cherry pick setups. Take all system signals as it is impossible to predict which system signals will be successful.

How Does the System Work?

Robert’s studies of the stock markets led him to ask two questions. First, why would a certain time period have either bullish or bearish tendencies? Second, even if that were the case then why wouldn’t big institutions take advantage of this and pretty much negate the advantage?

After working through decades of data, the case for seasonal indicators became very convincing to Steelman. He was able to identify seasonal tendencies which have existed for many decades, and theorized that they always be part of the markets. Using these seasonal tendencies to guide a trading system as to where and more importantly when to buy and sell is the main idea behind the Polaris system.

Polaris and its sister system SeasonalST are the result of a lengthy research encompassing over 30 years of S&P 500 index data and this research identified various seasonal patterns. The main difference between the Polaris system and its sister system SeasonalST is the holding period of the trades. Polaris’ trades are typically only 1-2 days in duration as the system is only looking to capture short term moves in the market. In comparison the original SeasonalST model can hold trades for up to 1 month, which proved to result in some significant drawdowns (knowing how much the S&P or Nasdaq can go from high to low in a month, you can see why).

For entries, the strategy signals long during periods with bullish tendencies and short for bearish tendencies. The signal strength is a combination of the strength of the seasonal pattern and how many patterns are in effect for the period. For the long signal the strategy normally expects at least two bullish patterns to coincide and for short signal at least two bearish patterns to coincide. There are several exceptions to this rule, with the main one being periods of extreme bullishness. Typically such bullish patterns last only a day or two and provide the quickest trades the system can issue.

Polaris can be traded with any trading vehicle tracking the S&P 500, Nasdaq, Dow Industrials indices, as well as the smaller SP 400 Midcap and Russell 2000 indices. However, trading the e-mini Futures markets is the choice of most investors due to favorable tax rules and leverage opportunities. The system is also suitable to traders with a modest account size, since it doesn’t require a huge portfolio to start, the recommended account size being $10,000 for one e-mini contract.

To recap – Polaris strategy:

- Trades last an average of 1 to 2 days.
- Long signal is issued on b bullish period.
- Short signal is issued on b bearish period.
- Research goes back over 30 years - to the year 1974
- Can be traded with e-mini SP, e-mini Nasdaq, e-mini Russell, e-mini SP Midcap, and mini DOW.
-Suitable for medium sized accounts with at least $10,000 allocated per contract.

Attain Comments:

It is not often that we will profile a system that has yet to be traded by Attain investors. Typically, in this newsletter we try and steer clear of systems with only a hypothetical track record as we know the pitfalls of hypothetical back testing. However, we decided to make an exception for the Polaris system based on two factors:

1.) We have significant experience trading the SeasonalST system which is also offered by Theseus Trading. Polaris & Seasonal have very similar trade entry logic and will often take many of the same signals. The biggest difference between the two systems is the exit strategy as Polaris holds trades over a much shorter time period. In many ways, Polaris can be seen as an upgrade to the SeasonalST program, which we do have live results for.

2.) Polaris has been incubated, or walked forward (trading hypothetically on a testing computer), at Attain for over two years without any changes to the system code. In a perfect world we would like to do this with every trading system as it allows us to gain confidence in the strategy and the developer behind the code. Plus with a long incubation period one can be assured that system is not “curve fit” to current market conditions.

Over the last two years Polaris has seen success across all 5 markets and especially on the smallcap indexes (SP Midcap & Russell 2000). In comparison the SeasonalST strategy has not done as well over the same time period due to some large drawdowns. This is where Polaris’ shorter trade length has been very advantageous. Because the system is typically only exposed to the market for 1-2 days it tends to avoid extended losing trades.

Other than making money, the main benefit of seasonal trading strategies is the instant diversification that they provide any traditional system portfolio. Because seasonal trading strategies are not bound by the same technical indicators and moving averages as mathematical systems, they can succeed in market conditions that a traditional trading system would struggle in. Therefore the correlation between Seasonal ST and a traditional swing trading system like AG Mechwarrior ES or Tzar ES can be very low.

As we have mentioned when discussing other seasonal systems (including SeasonalST) there are some areas of improvement that the system developers may want to consider investigating. First, unlike other mechanical trading systems, Polaris does not use protective stops, which can scare even the most experienced traders. The developers insist that stops only de-grade system performance as seasonal trades need to breath. Even though the system will only be exposed to the market for 1-2 days we wouldn’t mind seeing a little extra protection against adverse market movements.

Second, we worry that seasonal trading systems are more susceptible to changing market conditions than the average mathematical formula based system. What happens for example if the seasonal Santa Claus Rally turns into a Santa Claus sell off? Without traditional mathematical models will the system be able to adjust to changes? In short, this style of trading might be slightly more prone to system updates and other minor modifications than traditional trading systems, and this will be a challenge for the developer to manage accurately.

In closing, Polaris provides an excellent swing trading investment opportunity for any trader who is looking to expand his or her trading portfolio. Because of its non-mathematical focus, this system should provide excellent diversification opportunities especially for those who trade traditional swing trading or trend following strategies. In regards, to performance, Polaris eMD and Polaris eRL have been performing exceedingly well (hypothetically) and are both listed as Top 5 performers this week.

IMPORTANT RISK DISCLOSURE


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Feature | Week In Review: Metals Rebound, stocks head back to lows | Chart of the Week

***Overview***

Inflations worries seemed to be fanned again during the past week with gains seen in most commodity sectors. Industrial metals led the way with Copper ending the week up +6.36% followed closely by Palladium which soared 5.27%. Precious metals were also in play, especially with the U.S. dollar slumping, as Silver ended the week gaining +6.36% and Gold up +3.49%.

Soft commodities saw higher moves as well with inflation ideas and a weak U.S. Dollar sparking significant support in this sector. Sugar up +8.57% found additional support from ideas that bio-fuel use would gain due to corn crop problems in the U.S. Coffee was up +6.87% and Cocoa end the week up 3.98% soaring to multiyear highs.

U.S. equity markets accelerated lower last week as the prior week’s sideways activity easily gave way to a new round of selling due to more credit issues coming to light in the financial sector. News that the upcoming earnings season could produce further deterioration in earnings due to write downs from losses in the financing arena again came to the spotlight. For the week Dow futures lost -3.93%, the S&P futures shed -2.95%, and NASDAQ futures ended down -1.78%. The small-cap sector was also lower as the Russell down -2.39% and the Mid-Cap lost -1.70%.

What ailed the equities sparked support in the interest rate sector as the 30-year bond gained +1.76% and the benchmark 10-year note gained +1.03%, although gains seemed a bit subdued given the circumstances, mostly likely a result of the upcoming 2-day FOMC meeting this coming week.

Currency trading saw a decline by the U.S. Dollar, down -1.65% after a resent surge to 5+ month highs. The inflation factor seemed to play a part in the dollar demise as well as gains in the Euro Currency +1.52% and British Pound +1.59% seemed to favor the recent hawkish attitude from the EU central bank.

The grains and oilseed sector simmered a bit after the strong gains from the previous week on worries the severe flooding in key corn producing states in the U.S. Midwest would limit production. After a week of scouting crop damage it seemed the market was comfortable with the price increase given the period the crop season is in. For the week Wheat -1.87%, Soybeans -1.86% and corn lost -1.35%.

Energy futures ended the week fixed in a steady to lower tone as the Saudi Arabian special meeting among top energy officials seemed to cap and early week rally that was sparked again by the weekly stocks report that showed bigger than expected draw downs for U.S. crude stocks. Crude and RBOB ended the week nearly steady with heating oil -1.67%. Natural gas was up +2.94% as support stemmed from ideas summer usage could be higher than normal.

***CTAs***

With three weeks of trading in the books it looks like a pair of agriculture trading programs from NDX will be the top performing managed programs in June. NDX Shadrach leads with returns of approximately +12.97% for the month, putting it in the top spot amongst all programs tracked at Attain. NDX Shadrach is right behind in second place at approximately +6.36% for the month. NDX specializes in trading Hog Spreads and continues to impress thus far in 2008 after a disappointing ’07 campaign. Unfortunately other agriculture traders like Rosetta Capital (-1.15% est) and Chicago Capital (-0.95% est) have not fared as well in June.

In the option selling sector, Ascendant Strategy 1 is the top performer with approximate returns of +7.64% in June as the manager continues to battle his way out of drawdown. Next in line is LJM Partners with estimated returns of +3.53%, followed by Cervino Diversified with estimated returns of +2.15% , ACE SIPC at approximately +1.55% and Zephyr Aggressive with approximate returns of +1.42%. Other profitable option selling programs in June include Crescent Bay (+0.99% est), Raithel (+0.88% est), FCI (+0.85% est) and Diamond Capital (+0.55%). On the downside Zephyr Moderate at (-1.60% est) and Crescent Bay BVP (-0.77% est) are in the red thus far.

Multi-Market and trend following managers with long energy and grain positions continue to perform well, although last week’s pullback took some of the shine off their returns. The Attain Portfolio Advisors modified program (+4.98% est) continues to hold long in mini crude and mini natural gas, while also seeing gains on short stock index positions. The full size APA Strategic Diversification program is also in the black with returns of approximately +2.21% this month. The Dighton USA Swiss Futures program has had a great month of June so far with returns of +3.59% and continues to hold long in coffee. Several CTA’s including Long Term Trading (-4.01% est) and Hoffman Assett (-2.50% est) slipped into the red after holding profitable for most of June. Others including Optimus (-4.72% est) and Northside (-3.61% est) also remain in the red so far this month.

***Trading Systems***

Global equity markets continued their slide last week and are starting to feel like they could retest the yearly lows made in late March. Bond prices moved higher throughout the week, unlike the past few weeks when equities and bonds have been selling off in tandem. Overall, trading systems had favorable results with a few of the day trading systems catching the sell-off on Tuesday and Friday, and some of the swing systems that trade stock indices shifting their bias from long to short.

Beginning with the day trading systems, Rayo Plus Dax took the top honors: +$5,931.87 for the week. AG Xtreme 2 SP was not far off +$4,025 for the week on three trades. The program had trades on Monday, Tuesday and Friday all of which were winning trades. Compass SP was successful on two of three trades for the week with a net result of +$2,002.95. AK47 ES had one long trade on Monday for +$282.50 after the mutual funds did their usual round of buying to start the week. BetaCon 4/1 ESX was up +$63.39 on one short trade from Friday. Finally, Waugh eRL had three trades for a loss of -$870.

Moving on to the swing trading programs, Tzar eRL and NQ reversed short mid-week and were able to catch some of the sell-off to offset losses incurred from the long position that it held to start the week. Ultramini ES had one short trade on Tuesday that reached its target of +$632.50 and sat on the sidelines for the remainder of the week. Signum EBL and TY continue to hold short and saw a small bounce in both the German and US Ten Year Note. Mesa Notes attempted to go long a few times throughout the week but the orders were not elected, and the system was not in a position as of Friday’s close.

In long term trading, Aberration Plus went long Live Cattle and watched as prices were bid up to recent highs on Friday. The program continues to hold short in the Eurex Bund as do most trend following systems due to their relative weakness to the domestic bonds in the past few months.

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.