Margin Scaling (aggressive money management for CTA investing)
May 19, 2008
Many futures traders and commodity market investors have no doubt heard of the various money management techniques out there which in one way or another add to a position when that position is profitable. This technique is sometimes called pyramiding, sometimes pillaring, or margin scaling/trading – and the basis behind it is to use the “market’s money” to add to positions.
These money management techniques are usually thought of and implemented on an individual trade basis, and involve making enough in profits to cover the margin requirement for a new position; but can also be put into action on managed futures investments in CTA programs.
Normal Pyramiding/Margin Scaling:
But before we get into how it can work on a CTA program, let’s take a step back and see how it works on an individual market.
First, we’ll need a reminder on what margin is. Margin is the amount technically needed to place trades – as required by the futures exchanges. Any account which wishes to trade a futures contract on a regulated futures exchange like the Chicago Mercantile Exchange must first have enough money in the account to cover any potential losses (the margin) This insures that the exchange can make the trader who takes the other side of the trade good should the trade go against the account.
For example, the margin required to put on a Crude Oil futures position is about $4,500. Technically, all an investor needs to invest in that market is that small amount (even though the market can move 5 times that amount in a few weeks and you would be hard pressed to find anyone who would recommend trading it with such a small balance).
To do margin scaling money management (pyramiding/pillaring) on the Crude Oil futures, an investor would add a contract each time the account was ahead by the $4,500 margin amount. (or a move of $4.50 in the price of Crude) For example, say an investor bought a single December, 2008 Crude Oil futures in January ’07. That position would have been up about $8,500 as of March 3rd, as Crude climbed to 100 and a second contract could have been added. Two months later, on May 1st, another contract could be added as Crude prices climbed another $9 and open trade profits would have advanced by another $9,500.
By adding contracts only when the open trade profits are enough to cover the margin for the new contract you want to buy – an investor is using the “market’s money”, and doesn’t have to add capital to the account in order to increase the position.
Now – this is a very aggressive method of money management, and as such comes with a great deal of risk. In this case, Crude Oil futures could easily fall $15 in a single week, which would have lost the investor -$15,000 on their single contract, but will now lose them -$45,000 when adding two contracts using the margin scaling method. Basically, when you add the 2nd contract, you can lose money twice as fast as you made it; and when adding a third, three times as fast, and so on.
Scaling is a high risk, high reward endeavor only suitable for the most sophisticated of the already sophisticated investors involved in commodity investing.
Margin Scaling with CTAs:
With futures trading a zero sum game, and just as many investors out there losing money as there are making money - many investors may be happy enough to just find a program which makes money for them. But some of the more aggressive investors out there aren’t content to just make money, and frequently look for ways to make even more with their favorite CTA program or programs.
One such method these aggressive investors use to exponentially scale up the performance of a CTA is to “margin scale” the CTA. The backbone of this strategy is the same as what was outlined above, where the investor adds to a “position” when their account has enough profit to cover the margin for another contract.
But in the case of margin scaling with CTA programs - instead of adding a contract, the investor adds an allocation to the CTA (going from $100,000 investment to $200,000 for example). And instead of considering the margin requirement for an individual market, the investor uses the average or maximum margin the CTA uses.
Let’s use Attain’s own Strategic Diversification Program as an example. The Strategic Diversification program has a minimum of $1,000,000, and an average margin to equity ratio of 12.5%. That means on average, the total margin requirement for all of the program’s positions on any one day is about $125,000.
To margin scale this program, and investor would add an additional allocation to the program at every $125,000 in profits made in the account (including open trade gains). Again, with the idea that you’re playing with the “market’s money”.
The benefits of doing this are that profits can be compounded much quicker, creating exponential growth which dwarfs the normal performance. Using the Attain program as an example once again, for every $125K in gains the normal investor makes, the margin scaling investor doubles his or her profits (going from $125K to $375K to $750K, to $1,500K and so on.)
But the risks of doing this are that your absolute dollar risk gets doubled, then tripled, then quadrupled, and so on with every increase in allocation. Your absolute risk grows exponentially along with the profit potential. You can’t get something for nothing.
For more on the risks, imagine if the Attain Strategic Diversification Program had a 20% DD after making 25% ($250K). The initial allocation would merely lose the $250K it had made and be back to the initial investment of $1 Million. However, the investor who margin scales would have increased their allocation twice, and would be trading at a notional level of $3 Million plus $375K in profits when the drawdown hits. The margin scaling investor would then lose $675K (20% of $3.37 Million), and as such be down to just $325K out of the initial $1 Million investment.
But for those who understand the risks, and are looking to aggressively scale a CTA, this type of method can produce results. We ran tests of this method on our own Attain Strategic Diversification Program and the popular Dighton Capital program to see just how this exponential growth in risk and returns would look.
Test Reuslts:
To run our tests, we looked at the daily equity curve of each of the following programs, and assumed – for the Attain Strategic Diversification Program, that the daily profit/loss was doubled for each subsequent day after the program achieved $125,000 in profits up until the next $125,000 in profits, at which point the daily profit/loss was tripled, and so on for each $125K in profits – and for the Dighton Capital program, that the daily profit/loss was doubled for each subsequent day after the program achieved $33,000 in profits up until the next $33,000 in profits, at which point the daily profit/loss was tripled, and so on for each $33K in profits.
The results showed what we would expect, with violent growth in profits and risk. For the Dighton program, the allocation was increased a total of 26 times since July of 2005, leaving our fictional test investor trading a notional allocation of $2.6 Million with the program now, and having gained over $1.3 Million. That’s 800% more profits than the normal operation. In testing the Attain program, starting in January 2006, a margin scaler would have increased his/her allocation 15 times, and be trading $16 Million after having gained $1.5 million (344% more profit than the normal operation)
But, all good things have a price – and the price of that exponential growth was significantly increased risk (in absolute terms). The Max DD swelled from 44% to 90% in the Dighton program, and 10% to 42% in the Attain program. Likewise, the maximum dollar based drawdown swelled to -$538,000 in Dighton (as the equity curve moved from $752K down to $214K at one point.) and -$1.7 million scaling the Attain program (the equity curve moving from $4 Million down to $2.3 Million at one point) .
A normal investor would likely find these increases in drawdown extremely prohibitive. But an aggressive investor may look at those big dollar drawdowns and be fine with them, as the losses were still the “market’s money” (this fictitious investor in our tests only started with $100K with Dighton and $1 Million with Attain, remember; so any equity above those levels mean the investor is still playing with the market’s money).
This is the key to margin scaling, knowing the difference between relative losses and absolute losses. A very aggressive margin scaling investor would in theory be unconcerned with large percentage and dollar losses, as long as those losses are above their initial equity levels. They are fine risking large absolute numbers with the “market’s money” or profits.
But one would have to time their investment nearly perfectly in order to avoid any losses of the initial investment, and only have losses of the “market’s money”. And indeed, we can see in the last two rows of the results tables below the maximum amount of the initial capital the investor was down at any one point. In the case of margin scaling with the Dighton program – the investor would have been down $75K of their initial money (not the “market’s money”), versus only $9K under normal operation, while a margin scaler with the less volatile Attain program would have had better timing/luck with an initial capital drawdown of just 10% ($100K) versus 5.5% ($55K) under normal operation.
How much of the initial capital was lost is an important level to consider for the aggressive margin scaler, as they do not want to have much (if any) of the initial capital at risk if they can help it. Seeing an initial capital loss of 8 times the normal operation in the margin scaling results for the Dighton program would be an indication that program may not be a candidate for margin scaling.
In looking at these results, and considering that not only margin levels, but also future drawdown amounts affect how much capital is needed to hold a “position” with a CTA, a more conservative approach (although still more aggressive than normal operation) could be to add allocations based of making profits equal to the average margin used plus the average annual drawdown amount, or max DD. This would make it harder for the money management technique to add an allocation, and build in a cushion of profits to protect against a drawdown happening right when the allocation is increased.
- <!--[endif]-->Jeff Malec
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.
Feature | Week In Review | Chart of the Week | Top 5 CTAs | Top 5 Systems |
Feature | Week In Review | Chart of the Week | Top 5 CTAs | Top 5 Systems |
***Overview***
A week of favorable economic releases and some pleasant earnings releases led to an up week for stocks as most indices neared levels not seen since early to mid January. The main catalyst for the rally was a stronger than expected retail sales figure for April and a rebound in housing starts for the first time in five months. The leader for the sector this week was the NASDAQ futures which gained +3.55% as support in the tech sector continues to emanate from the possible takeover/buyout of Yahoo. SP futures rose +2.59% for the week and the Dow futures gained +1.85%. In small cap trading the SP Midcap futures gained +3.47% and Russell 2000 futures were up +2.95%.
Inflation fears continue to be supporting factor for the Precious and Industrial metal sectors as growth in the Middle East and Asia continue to spark buying confidence. Private forecasters continued to release figures this past week indicating inflation remains a strong factor for most emerging economies. For the week Copper gained +2.98%, Palladium was up +2.19%, Gold rose +1.67%, and Platinum was +1.52% higher.
Most energy futures continued on their trek higher as continued geopolitical tension and supply disruptions kept market participants to the task of adding more risk premium. For the Natural Gas futures, -3.94%, it was a different story as supply worries seemed to ebb on the weekly stocks release that showed a build in supplies much greater than the market anticipated. Heating Oil rose +1.91%, RBOB Gas was up .70%, and Crude ended +.37% for the week.
It was another slow week for currency and bond trading as the US Dollar finished the week a touch lower against most continentals. US Dollar Index futures fell -.45% for the week as investors seemed undecided on price action after the recent rally. Lower trade was also sparked by the private forecasts of strong economic conditions in emerging countries. Euro Currency, Swiss Franc futures ended slightly higher for the week with the British Pound down -.9%, and Yen-1.36%. In bond trading the benchmark US 10 Year Note futures finished the week -.81%, and the US 30 Year Bond futures were down -.90% as the sector continues to trade in a sideways trend looking for a more confirming sign of economic conditions in the U.S.
The Soft commodity sector was mostly lower during the past week as supply worries seem to subside for most sectors. Corn -6.1% and Wheat -4.21% fell on ideas the U.S. crops will be better than expected, although Soybeans were up +1.56% due to the continued Argentine farmers strike. In other food sectors Coffee futures gained +1.48%, while Orange Juice -9.65%, Sugar -3.63%, and Cocoa -2.34% fell on improving growing conditions.
***CTAs***
As we have discussed several times in this section, many of the option selling mangers we track have a tendency to produce a higher frequency of winning months than losing months (past performance is not necessarily indicative of future results). So far May is leaning toward one of those positive months with several mangers trading at or very near new equity highs. Month to date ACE Investment Strategist has been the top producer earning an estimated 3.75%. After hitting a new maximum drawdown of -28% last August Ace is now less than 2% off of a new equity high and is ahead +24.29% for the last 12 months (though April). Another manger in a similar situation is FCI, who is ahead approximately +1.3% MTD and is now within 2% of a new equity high. FCI is now ahead almost +10% for the YTD.
Other profitable option results include Ascendant Strategic 1 +2.19%, Zephyr Aggressive +1.52%, Cervino COP +1.43%, and Diamond Capital +0.5%. A number of mangers including Zenith, Cervino Diversified, Crescent Bay PSI, and Rathiel are all very close to break even. Crescent Bay BVP is down -0.84% following the market run up against their short call positions.
As odd as it sounds, May has presented a wide range of results for the small niche strategy group of Agriculture traders. The top performer has been NDX suite of programs with Shadrach up +1.84% and Abednego +1.09%. NDX Shadrach was ahead +12.09% for the YTD though April and ahead +27.28% for the past 12 months - the maximum drawdown over the period has been 13.7%. On the other hand, Chicago Capital is break even for the month and Rosetta is down -6.33%. For investors looking for an opportunity to buy into Rosetta on a pull back from their recent equity highs please note that the program is currently in an estimated 12% drawdown - the program was ahead +48.38% over the past 12 months though the end of April.
Multi market managers have bounced back nicely in May, and had another strong week last week. Those that are long energies have done exceedingly well as these markets continue to trade at record high prices. Vision Capital Management has been the most aggressive manager in the energy sector with long positions in the NYMEX (New York), TOCOM (Tokyo) and IPE (London) marketplaces. Thus far, holding long across the board has worked in the manager’s favor as Vision Capital is up approximately +21.45% for the month. However, it is worth noting, that with the recent volatility seen in the energy sector those gains could come off the board very quickly.
Other managers that have also performed well this month are Longtermtrading.com and Hoffman Asset Management. Longtermtrading.com has found success in both the energy and metals sectors while Hoffman Asset has profitable positions in palm oil and treasury futures. The Attain Portfolio Advisors Modified Program has also bounced back gaining +2.19% this month. This program is currently long in the e-mini stock indexes, energies, and foreign currency markets. Finally Northside Trading is up slightly for the month at +0.41%.
On the downside the Optimus Capital program is down -2.39% in May after a couple losing trades. The Robinson Langley program is down as well at -0.74% after getting stopped out of long sugar and corn trades last week. The Attain Portfolio Advisors Strategic Diversification Program is also down slightly at -0.22% after suffering day trading losses late last week.
In F/X trading, the Wallwood FX program leads the pack in May with returns of +2.34% and is currently long in the Euro. The PFG FIT FX program from PFG Managed FX is down -0.07% for the month. Currently FIT is flat and is not holding any open positions. Also in the red is the PFG Devrim FX program which has lost -1.24% in May. Devrim, which has yet to have a losing month while trading at PFG, has had a tough go of it thus far in May after recent losing trades in the Euro, Aussie Dollar, and Canadian Dollar
***Trading Systems***
Day trading systems struggled to cling on to profits last week despite the upward trend in equities and corresponding move lower in treasuries. Several intraday reversals made it difficult for trading systems to maintain their positions long enough to be profitable, often getting stopped out before a continuation of the trend later in the session. Waugh eRL was the closest to finishing in positive territory with a small loss of -$60. Beta v2 Dax was close behind with a loss of -$93.20 on one trade from Wednesday. BetaCon 4/1 ESX continued its May losing streak with a loss of -$216.25.
Elsewhere, Compass SP lost -$587.50 on four trades for the week. Kappa 12/1 Dax had similar results of -$658.43 for the week on an equal amount of trades. Finally, Rayo Plus Dax lost -$3,585.87 for the week.
Moving on to the swing systems, most of the programs held their respective positions. Tzar ES reversed short late in the week for +$1,895 including open trade profits while the eRL held short and the NQ long. Signum TY reversed short, then back to long later in the week while the EBL reversed short and maintained its position heading into the weekend.
Consistent with the other systems, there was virtually no activity for the long term systems. Aberration Plus continues to hold short in the Dollar Index and Eurex Bund and added no new positions last week.
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.
Feature | Week In Review | Chart of the Week | Top 5 CTAs | Top 5 Systems |
Past Performance is Not Necessarily Indicative of Future Results.
| Rank | Program Name | 12 month Return | 12 month Drawdown | Min Investment (k) |
| 1 | James H. Jones Diversified Portfolio | 130.03% | 3.50% | $250 |
| 2 | Clarke Capital Management, Inc. Millennium | 107.06% | 7.13% | $1,000 |
| 3 | Parrot Trading Partners, LLC | 140.59% | 11.48% | $100 |
| 4 | Dighton Capital USA Swiss Futures Trading | 139.20% | 15.38% | $100 |
| 5 | Attain Portfolio Advisors Modified Program | 96.83% | 9.89% | $250 |
Figures listed are as of 5/19/2008.
IMPORTANT RISK DISCLOSURE
The rankings above are the top ranked CTAs offered at Attain over the past 12 months using a risk adjusted ratio which equals the period return divided by the period DD.
Investments in CTAs can be subject to substantial charges for management and advisory fees. The % returns in the CTA table above include all such fees, but it may be necessary for those accounts that are subject to these charges to make substantial trading profits in the future to avoid depletion or exhaustion of their assets.
The regulations of the Commodity Futures Trading Commission (CFTC) require that prospective clients of a CTA receive a disclosure document when they are solicited to enter into an agreement whereby the CTA will direct or guide the client's commodity interest trading and that certain risk factors be highlighted. The disclosure document contains a complete description of the principal risk factors and each fee to be charged to your account by the Commodity Trading Advisor (CTA). This document is readily accessible at this site using the Disclosure Document link at the Attain website.
Feature | Week In Review | Chart of the Week | Top 5 CTAs | Top 5 Systems |
Hypothetical Model Accounts using Computer Generated and Actual Client Fills.
| Rank | System Name | 90 Day Return | Return in Dollars | 90 Day Drawdown | DD in Dollars | Min Investment (k) |
| 1 | AG Mechwarrior ES | 68.43% | $10,264.00 | 17.13% | $2,570.00 | $15 |
| 2 | Signum EBL | 17.68% | $7,072.70 | 6.27% | $2,507.08 | $40 |
| 3 | Kappa 12/1 DAX | 19.71% | $4,238.52 | 14.94% | $3,212.44 | $22 |
| 4 | Bounce EMD Swing | 17.83% | $1,783.39 | 14.75% | $1,474.61 | $10 |
| 5 | Delta Plus 0212 DAX | 12.90% | $5,999.46 | 13.29% | $6,177.78 | $47 |
Figures listed are as of 5/19/2008.
IMPORTANT RISK DISCLOSURE
The rankings above are the top ranked Trading Systems offered at Attain over the past 90 days using a risk adjusted ratio which equals the period return divided by the period DD.
The % returns in the trading system table above are hypothetical in that they represent returns in a model account. The model account rises or falls by the exact single contract profit and loss achieved by clients trading actual money pursuant to the listed system's trading signals on the appropriate dates, or if no actual client profit or loss available - by the hypothetical single contract profit and loss of trades generated by the system's trading signals over the test period. The hypothetical model account begins with the initial capital level listed, and is reset to that amount each month. The % returns reflect inclusion of commissions, fees, and the cost of the system. Commission and fee cost = # of monthly trades * $50.00 ($30 for eminis). The monthly cost of the system is subtracted from the net profit/loss prior to calculating the % return. For systems with one time purchase costs, the monthly cost is calculated by dividing the purchase cost by the number of months in the reporting period.
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.
THESE PERFORMANCE TABLES AND RESULTS ARE HYPOTHETICAL IN NATURE AND DO NOT REPRESENT TRADING IN ACTUAL ACCOUNTS.