How Much to Risk in a Risk On/Risk Off Market

Yesterday we covered the correlation levels between the various traditional asset classes, but today, we’re more interested in the correlation between the markets themselves. While traditional stock brokers were lamenting the rise in correlation among various stocks, CTAs in the managed futures space were becoming frustrated by the way the risk on/risk off plays were impacting correlation among the various futures markets.

As a refresher, correlation simply refers to a numeric connection between two events. The number of people wearing shorts in Chicago, for example, is positively correlated with how warm the temperature is, while the number of people wearing gloves is negatively correlated with how warm the temperature is. The warmer it is, the less people wear gloves and the more people wear shorts. While we can easily see that connection in our minds – seeing such connections between investment returns can often prove difficult. While correlation may be used to analyze market movements, it is important to note that correlation is not the same thing as causation. In other words, just because there is a connection does not mean that one event was caused by another.

In managed futures, managers might specifically select markets for their programs based on a variety of factors. For some, it’s merely based on the levels of liquidity and volatility in a given market. For others, it’s about trading what they’re familiar with. For others still, it’s about these correlation levels between the markets they choose to participate in, whether it’s related to limits in positions that can be taken at a single time, or limits on which markets they can touch to begin with. In a world where trading switches to a risk on/risk off environment, those that have selected their market participation based on correlation levels may find themselves facing a headache.

How much of a headache were these CTAs facing in 2011? We ran the data across 28 different markets for the 2011 as a whole, and while the data was revealing, it wasn’t quite as hard-hitting until held in context, so we also ran the data for January-June of 2011, July-December of 2011, and 2000-2010. If a picture is worth a thousand words, the correlation matrices below are representative of millions of dollars in headaches in the futures markets. The markets are organized by sector, with the blue lines denoting correlation levels within sectors, which you’d typically expect to be moderately high. The correlation levels are shaded according to severity, with strong positive correlations shaded a darker green, strong negative correlation shaded a darker red, and non-correlation shaded with a yellow. Numbers falling in-between these levels are shaded correspondingly. You’ll notice that 2011 definitely saw higher levels of correlation across the board in comparison to the decade prior, but more significantly, that the second half of 2011 witnessed particularly strong levels of correlation between the various markets. What will 2012 hold? Well, the first day of trading would have indicated more of the same, but with a more mixed bag coming out of yesterday’s pit session, we’re hoping we see a far more yellow board at the end of this year.

Disclaimer: Past performance is not necessarily indicative of future results.

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Disclaimer
The performance data displayed herein is compiled from various sources, including BarclayHedge, 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.

Benchmark index performance is for the constituents of that index only, and does not represent the entire universe of possible investments within that asset class. And further, that there can be limitations and biases to indices such as survivorship, self reporting, and instant history.

Managed futures accounts can subject to substantial charges for management and advisory fees. The numbers within this website 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.

Investors interested in investing with a managed futures program (excepting those programs which are offered exclusively to qualified eligible persons as that term is defined by CFTC regulation 4.7) will be required to receive and sign off on a disclosure document in compliance with certain CFT rules The disclosure documents contains a complete description of the principal risk factors and each fee to be charged to your account by the CTA, as well as the composite performance of accounts under the CTA's management over at least the most recent five years. Investor interested in investing in any of the programs on this website are urged to carefully read these disclosure documents, including, but not limited to the performance information, before investing in any such programs.

Those investors who are qualified eligible persons as that term is defined by CFTC regulation 4.7 and interested in investing in a program exempt from having to provide a disclosure document and considered by the regulations to be sophisticated enough to understand the risks and be able to interpret the accuracy and completeness of any performance information on their own.

RCM receives a portion of the commodity brokerage commissions you pay in connection with your futures trading and/or a portion of the interest income (if any) earned on an account's assets. The listed manager may also pay RCM a portion of the fees they receive from accounts introduced to them by RCM.

See the full terms of use and risk disclaimer here.

Disclaimer
The performance data displayed herein is compiled from various sources, including BarclayHedge, 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.

Benchmark index performance is for the constituents of that index only, and does not represent the entire universe of possible investments within that asset class. And further, that there can be limitations and biases to indices such as survivorship, self reporting, and instant history.

Managed futures accounts can subject to substantial charges for management and advisory fees. The numbers within this website 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.

Investors interested in investing with a managed futures program (excepting those programs which are offered exclusively to qualified eligible persons as that term is defined by CFTC regulation 4.7) will be required to receive and sign off on a disclosure document in compliance with certain CFT rules The disclosure documents contains a complete description of the principal risk factors and each fee to be charged to your account by the CTA, as well as the composite performance of accounts under the CTA's management over at least the most recent five years. Investor interested in investing in any of the programs on this website are urged to carefully read these disclosure documents, including, but not limited to the performance information, before investing in any such programs.

Those investors who are qualified eligible persons as that term is defined by CFTC regulation 4.7 and interested in investing in a program exempt from having to provide a disclosure document and considered by the regulations to be sophisticated enough to understand the risks and be able to interpret the accuracy and completeness of any performance information on their own.

RCM receives a portion of the commodity brokerage commissions you pay in connection with your futures trading and/or a portion of the interest income (if any) earned on an account's assets. The listed manager may also pay RCM a portion of the fees they receive from accounts introduced to them by RCM.

See the full terms of use and risk disclaimer here.

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