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Questions and Answers

Why the free rules?

In spite of popular beliefs, diversified futures trend following does not require an advance degree in quantum mechanics. The industry has been trying to keep the details of these trading strategies clouded in mystery for a long time, which is understandable since most of them can be replicated with quite simple strategies. I show the core rules on this site with enough details for any motivated professional to be able to replicate and verify the results. I believe the time of the black box strategies is on its way out and that a bit of transparency is in everyone’s interest.

So what’s the catch?

There is no catch. Oh, and did I mention that I’ve published some books on this topic? Sure, you can buy them on Amazon. Go on, order them right away. Yes, I’ll wait.

What is the underlying idea of the strategy?

Financial markets move in trends for the reason that real world developments move in trends. For any given market, most of the time there is no tradable trend and the choppy sideways movements will just cause losses for this type of strategy, but that is the reason why we are trading a large set of markets covering everything from the S&P Index to gold, livestock and interest rates. Expect to lose on over 60% of all trades but those losses will be small relative to the gains on the winners and the overall portfolio return will in the long run have a positive expected return.

Your strategy is just simple breakout with trend filter!

Sure, and that is exactly the point I’m trying to make. You don’t need a complicated strategy to achieve the results the strong long term results that the futures funds have been showing for the past decades, you just need strategy that is good enough and make sure it is properly diversified. The fact of the matter is that most CTA funds use strategies very similar to this one. A strategy sold for ten thousand bucks is not necessarily a better strategy than one you can get for free and to really trust this statement you need to do your own homework, program the strategy into a proper simulation software and run a realistic portfolio simulation over time. Don’t take anything at face value. Do the work and verify it.

What if I trade the strategy on just one or two markets?

Then you will probably end up losing a lot of money and give up in frustration.

What if I trade ten markets?

That would be taking a too large risk and missing the point of the strategy. Trading anything less than 40 markets means too little diversification and too high risk.

What if I want lower risk level than the default strategy?

Easy, just change the risk factor in the position sizing formula to a lower number. By default, the strategy takes a theoretical risk of 20 basis points daily price move, based on the average true range on position open. Lower or raise this number to fit your own volatility appetite. Higher number means higher expected rate of return but also higher risk and deeper drawdowns and vice versa.

How much money do I need to trade this strategy?

If this is any catch, this is probably it. I would strongly advise anyone against trading diversified futures trend following strategies with an asset base less than one million dollars. Well perhaps you can trade with a bit less if you are willing to take on quite high levels of volatility, but don’t confuse this with a strategy you can run on a 10k margin account. It just won’t allow you enough diversification unless you take on so much risk that you are likely to wipe out the whole account at the first sign of trouble.

One problem with futures as instruments is that they are not divisible to the extent as stocks. For some markets there are liquid mini contracts others not. In the equity index futures space there is no shortage of mini futures available and for currencies it’s not a big concern either. In the commodity sector though the coverage of minis is spotty at best and for the very important rates sector its practically non-existent.

If you only trade with 150,000, you get a signal to buy Live Cattle using a risk factor of 0.2% and the average true range is at 1.97 the strategy would tell you to buy 0.4 contracts which of course is not possible. Either you need to drastically reduce the investment universe or significantly raise the risk factor and either path would shift the overall risk into levels where I would not recommend going.

But this other website says I can buy a professional trend following cross asset system where I only need a few thousand and it has a huge return potential!

Good luck with that.

8 comments

  1. “I would strongly advise anyone against trading diversified futures trend following strategies with an asset base less than one million dollars. “

    Most people who will buy your book will not be millionaires.
    Why not use the same strategy with ETF’s or CFD’s?

  2. Perhaps CFDs. I’m looking into that possibility on behalf of an investment bank. Results are not in yet. You have the added spread to deal with and a counter party risk. Also, to my knowledge CFDs are not allowed stateside.

    ETFs are not an option for these types of strategies. Other types of trend models on ETFs are possible, but the mechanics would have to be heavily modified for the loss of leverage.

  3. For CFDs, you can choose a good broker. I am with IB and very satisfied. They have transparent quotes for CFDs. (http://ibkb.interactivebrokers.com/node/1984).

    PS: I have no relation with IB, only a client.

  4. Indeed, CFDs are not available to US citizens. But that shouldn’t stop the rest of us.

    For IB, they don’t offer commodity CFDs 🙁

  5. Hi. I am wondering what time series you are using for testing between floor/pit, electronic, or combined. You often write “buy at the open the following day.. following a signal based on close the day before”. This would imply using a floor based time series. Is that correct? However, the most liquid contracts are normally electronic. Can you please clarify this point? thanks.
    Mark

    • Where available, I use electronic markets, Mark. Sure, for some markets you could argue about the semantics of an opening and closing price, but there’s almost always an official open and close, even for 24h markets.

      The definition of open and close are not terribly important though, as long as your simulations allow for a realistic delay between trigger price and execution price.

  6. Andreas,

    Do you think there is potential for long dated options to give enough leverage across a diverse set of ETFs for this system?

    Thanks,
    Derrick P.

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