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5.5 Steps to Finding the Right CTA for You.

May 21, 2007

 

Look around you next time your at the grocery store, mall, or a restaurant. Do we all wear the same fashions, drive the same make and model cars, or love the same foods? We sure don't. Some people need larger clothes, a safer car, or spicier food because they have special circumstances, wants, or needs.

The same is true in investing where you are still an individual with different needs than the next investor. So instead of looking for the best CTA or system, investors should really look for the best CTA or system for THEM. The following are 5.5 specific guidelines for finding the right CTA or trading system for YOU.

#1 - Check your existing portfolio: Are you long a lot of stock in your existing portfolio? Are you invested in a stock index option selling CTA already? If so, would it make sense to invest in a CTA which sells options and would do poorly if the stock market crashed? Of course not you would be increasing your stock market exposure instead of diversifying it. No matter what the statistical correlation is, the right CTA for you might be one that does something completely different than what you're currently exposed to.

#2 - Do you trust the Manager? This is more important for a CTA than in trading systems, as a CTA manager has the authority and ability to override the program, make changes, or dial up risk. In a CTA investment, who is managing the money is equally as important as how they are managing it. Specific things to look at are whether the CTA is a one man shop, with the manger acting as the secretary, trader, and accountant all at the same time. What happens to your money if he gets hit by a bus? Also important is how the manager acts during times of stress - do they keep communicating with the clients, or do they disappear. The latter is obviously a red flag.

#3 - Calculate how much capital you are risking: Too many investors rush into a CTA investment based on good looking performance without assessing the risk behind the numbers. While the past maximum drawdown is a good measure of what has happened, looking at the CTAs average margin to equity and max margin to equity ratios will tell you what could happen. The exchanges use margin as a rough estimate of the worst case scenario for a position on any one day, so if a CTA has an average margin to equity ratio of 50%, that means they are risking roughly 50% of the account each day. In an ideal world, the CTA who can make the same amount of money without putting as much equity at risk is the better choice. Knowing a CTA's margin/equity ratios will also help in mapping out a total portfolio, as excess equity not being used by one CTA can be simultaneously allocated to another via notional funding. See our newsletter on notional funding.

#4 - Don't pay upfront fees, make sure you can buy T-Bills: Some CTAs are offered through brokerage firms which charge up front sales fees. Don't pay such fees. Issues are: 1. The investor usually invests based upon a CTA track record, but that track record does not include the up front charge. 2. The investor stands to make considerably less with the CTA program over the course of the investment. And 3. It's not a requirement for participation in the CTA program (you don't have to pay it !!) Next, make sure you can buy T-Bills with the majority of the money you've invested with the CTA, and make sure you have the T-Bills in a separate account, so that the CTA doesn't get 20% of the profits due to the interest. This can add an extra 4% or so to your annual returns.

#5 - Do a Personality Test - This may seem like something more important to Internet dating than commodity futures investing, but the better a CTA fits your personality, the better chance you have of long-term success. Too many times, a person who is terrified of a stock market crash will invest in a CTA who sells Puts on the S&P 500 and then wonder why the investment makes them so nervous. Or an investor who tracks commodity price movements daily won't understand why a long term trend follower didn't catch the day's move. An investor needs to look past the performance figures and look at the trading style of the CTA to insure it fits their personality. Use the Warren Buffet rules of investing - if you don't understand it, or don't agree with it, don't invest in it.

 

#5.5 - Use a Professional CTA Brokerage Firm - If you could fly first class for the same price as coach, wouldn't you? The same metaphor applies to CTAs, where investors pay the same management and incentive fees whether they go through a brokerage firm like Attain or not. So why not fly first class and get much, much more. Before investing, there is the extensive due diligence done by Attain - checking statements to audit performance, calling references, verifying registration with regulators, interviewing the managers, and more. After investing, help is never more than one ring away on the phone, while Attain monitors the account daily to insure the CTA is trading as they said they would, notifies clients of any trading outside the norm, and helps manage excess cash with related accounts and T-Bills.

 

5.5 Steps to Finding the Right Trading System for You

#1 - Don't Try to Reinvent the Wheel The first step to finding a good trading system is not to fool yourself into believing you have to create it. Most investors think they can do it themselves; while the number of hours, days and years professional developers have spent developing their wares simply dwarfs the amount of time any one individual can put toward the endeavor.

#2 - Avoid Trading Schools, Indicator Packages and Trading Software Many so-called trading systems available today are anything but, and it is important to identify these for what they truly are. A trading school is not a system; an indicator package is not a system; and trading software programs that allow users to change the variables are not trading systems. These are not systems because they aren't mechanical, and they don't make your trading consistent. At best, they can be used by traders to create a system; at worst, they are the trading equivalent of a horoscope, always telling the naïve and needy what they want to hear.

#3 - Know the Developer One rule of thumb which seems painfully obvious is the one most often broken. Actually talk to the developer of the system you are considering for purchase. Be careful of those systems that have websites without contact information. These developers may be hiding who and where they are for a reason. Also beware of the hard sell and promises of profits without mention of the possibility of losses or mention of drawdowns. Ideally, if you are trading futures contracts, you only want to deal with registered developers. You can verify whether a developer you're looking at is registered by checking the NFA's background search tool.

#4 - Find Some Actual Trading Results What appears to work on a computer simulation can be very different than what will work once you begin actual trading, and for that reason, it's imperative you seek out some actual trading results. Actual results are the proof and, in our opinion, show a system's true colors. Whether intentional or not, there are just too many biases built into computer backtesting using past data, as you KNOW what happened. This tendency to "fit" a system's parameters to known data is called "curve fitting." One of the unfortunate hallmarks of a curve-fit system is its inability to make money in real time, with real money on the line. An easy way to combat this and find systems that are less apt to be curvefit is to find some actual trading results for the system you are interested in.

#5 - Do a Personality Test This may seem like something more important to Internet dating than trading systems, but the better a system fits your personality, the better chance you have of long-term success. Too many times, a person who insists on seeing more winning trades than losing ones will invest in a system with a winning percentage less than 50 percent and then will wonder why this investment is not meeting his expectations. An investor needs to look past the performance figures and look at the personality of the

#5.5 - Use a Professional Trading System Brokerage Firm On the execution side, a professional trading system firm has a room full of traders dedicated to monitoring the trading system you're looking at. An individual investor would have to sit in front of the machine throughout the day or hire someone at a much higher cost to do so. If you're thinking you can rely on auto-execution software, be very cautious of the many pitfalls and errors possible with that software. It only takes one mistake to wipe out an account. Beyond the physical requirements, a trading system broker typically has more experience, data and history with trading systems than an individual investor could gather, as well as other technological necessities - computer redundancy, multiple data streams and offsite backups, to name a few. Finally, a professional trading system firm has experience with hundreds of different trading systems and can tell investors and traders what they have seen and what they think - from an educated, objective viewpoint.

- Walter Gallwas