The Hidden Cost of Volatility Drag

The Market's Most Successful Managers

The past year was a tumultuous one for commodity trading advisors (CTA). Despite the market's best efforts in 2008, some managers managed to outperform the competition, while others struggled to keep pace. To understand why this happened, we need to delve into the world of trend followers and discretionary traders.

Discretionary Traders Who Thrived

One such manager is John Hummel, principal of AIS Futures Management. His program, which follows a 2X-4X strategy, returned an impressive 64.31% in 2009 while allowing him to remain on the sidelines throughout the year's ups and downs.

Hummel attributes his success to his long-term approach, which prioritizes discipline over short-term gains. He stays disciplined with his positions, recognizing that even small deviations from his strategy can lead to significant losses if not managed properly.

The Power of Discretionary Trading

Discretionary trading offers a unique advantage in volatile markets like 2009. By allowing himself some discretion, Hummel was able to ride out periods of high volatility while avoiding the sharp reversals that often occur during market downturns.

This approach is supported by Stanley Haar, principal of Barclay Discretionary Traders Index, who notes that discretionary traders have historically performed better in markets with low correlation between different sectors and assets. In his words, "the political situation is fragile," which suggests that markets may be more susceptible to sudden changes in government policies or economic conditions.

A Cautionary Tale: The Importance of Risk Management

While discretion can be a powerful tool for traders, it's equally important to acknowledge the risks involved. Michael Frischmeyer, a discretionary trader with AIS Futures Management, recognizes the importance of managing risk and allowing his positions to move adversely when necessary.

Frischmeyer notes that recognizing the markets' ebb and flow is essential for long-term success. By loosening his risk management in certain situations, he was able to avoid being chopped up by market reversals and maintain a steady stream of profits.

Sector Correlation: A Key Factor in 2009

One factor that contributed to the relative stability of managed futures in 2009 is sector correlation. Jay Feuerstein, principal of 2100 Xenon, attributes his program's success to its ability to adapt to changing market conditions and avoid being tied down by highly correlated positions.

When asked about the challenges he faced in 2009, Feuerstein simply produces a daily bund chart that illustrates extremely choppy markets. "Choppy markets hurt our mean reverting trades," he says. This highlights the importance of diversification and adaptability in managing risk.

A New Era for Managed Futures

The managed futures market has undergone significant changes in recent years, with many firms shifting their focus towards more diversified strategies. While some traders may be hesitant to adopt these new approaches, others have found success by embracing flexibility and a long-term perspective.

As we look ahead to the future of commodities trading, it's clear that discretion will remain an essential tool for managers seeking to navigate volatile markets. By understanding the intricacies of sector correlation and adapting their strategies accordingly, traders can increase their chances of success in the years to come.