Tag: Futures Trading

Home  Futures Educational Videos

Futures orders are placed by using a broker’s trade execution platform. Using the broker of your choice, a trader will place orders using that platform.

Traders rely on software provided by their broker to place orders. While all software allows traders to place orders for futures contracts, each broker’s software will look a little different and may include different features.

The execution platform can either be visual, where traders drag and drop orders, commonly referred to as a Depth of Market or DOM; or an entry screen, where traders type in the parameters of their order.

Most brokers have a desktop and mobile version of their platforms, allowing them to place orders and monitor their account from anywhere there is a connection to the internet. This is a huge change from just a few years ago, where orders were telephoned in to the broker. Real-time streaming data has also leveled the playing field for individual traders as they are no longer looking at prices from 15 to 20 minutes in the past.

The trading screen will provide information, like contract name and expiry, current bid and ask prices, and the number of orders placed in the market at various prices. The number of orders are typically shown 5 to 10 ticks above and below the current price of the futures contract. Many trading DOMs also show the daily volume that has traded at each price level, allowing traders to see at which prices traders had interest in buying or selling the futures contract.

While there are many brokers, all electronic orders for CME Group products are routed through the CME Globex electronic trading platform.

Electronic orders are matched on CME Globex through algorithms that support order management functionalities offered to market participants and ensure that each market participant is given the best possible execution at the fairest price.

Prior to placing an order, a Trader will make decisions about:

• What futures contract to trade
• The expiry date of the contract
• Buy to open or sell to open
• Number of contracts to trade
• The price at which they want to execute the order

What Contracts to Trade

Traders will first analyze the market to determine the contract they wish to trade. Each contract has various characteristics, like typical size of moves, or dollar value per point; a trader must be familiar with the specifics of each contract prior to entering an order. CME Group offers futures contracts in a wide variety of markets: Equity Indexes, Interest Rate Products, Agricultural Commodities, Foreign Exchange, Metals and Energy.

Expiry

After selecting the contract, a trader will select the expiry month to trade. Many individual traders select the futures contract with the nearest expiry, which will most often be the actively traded contract based on the most daily volume. Many traders use the current contract and then roll to the next contract if they want to hold the futures contract past expiry.

Buy or Sell

The trader will then decide to either buy the futures contract, if they think price is moving up, or sell the contract, if they think price is moving down in the future. Traders will typically use technical analysis, fundamental analysis or a combination of the two to make their trading decisions and will develop specific strategies to help determine if they should buy or sell.

How Many Contracts to Trade

Based on account size and individual risk parameters, a trader also chooses how many contracts to trade.

Position sizing is an important factor in trading futures contracts; trading the correct number of contracts for your account size and investing goals is important and can have a large impact on your trading account. Position sizing is up to the individual trader, but you can contact a registered broker or financial advisor if you need assistance determining an appropriate amount of risk.

Execution Price

Traders need to select a price at which they will enter the order. Orders can be placed at market, which is the current price that the futures contract is trading, or as a limit order, which is an order placed away from where price is currently trading, in anticipation of price moving towards the order to get filled.

For example, a trader using the DOM can place an order by buying one contract near current price or can enter an order by placing it further away from where price is currently trading to get filled once price moves to levels they want to be filled at to enter the order.

Stops and targets can also be added to the DOM as plans to exit for either a loss or profit. Stop loss and orders to exit a position at a profit can be placed to trigger automatically or can be entered manually at the time the trader wants to exit the position.

Margin

As you make your decision about contract size, remember that all futures contracts are traded with margin. This means you only need a portion of the contracts total cost to be in your account to trade the contract.

For example, suppose you can trade the E-mini S&P500 futures contract with several brokers for $500 of day margin. ES has a value of around $50 x 2500 = $125,000, this means that for $500 of cash in your trading account you can control $125,000 of value in the market. This has the effect of having a magnifying effect on both gains and losses.

Each market will have different margin requirements, which vary by contract and whether you are trading during the day or overnight. Each broker will have a list of the margin requirements per contract. Most brokerage platforms provide real-time margin calculations that allow traders to know how much margin they have remaining in their account to determine how many trades can be placed. Prior to entering any order, a trader should be aware of the margin required for the futures contract they are trading.

Conclusion

Once a trade has been entered, the brokerage platform will show the trader in real-time that their order has been accepted by the exchange, the price the order was filled at, and current real-time profit and loss (P&L) of the trade.

Entering an order is only one aspect of trading, there are many more steps that traders will need to know to successfully manage a trade from beginning to end.

For additional information on order types, please visit:

• Order Types for Futures and Options
• Order Qualifiers
• Order Management
• Matching Algorithms

If you have questions send us a message or schedule an online review .

Regards,
Peter Knight Advisor

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Home  Futures Educational Videos

CME Group provides clearing services for customers around the globe through our clearinghouse, CME Clearing, which enables market participants to significantly mitigate and manage their risk exposures.

A clearing house, like CME Clearing, is an intermediary between buyers and sellers in the derivatives market. As the intermediary, or counterparty, to every trade, CME Clearing acts as the buyer for every seller and the seller for every buyer for every trade.

By acting as the counterparty for every trade, CME Clearing helps you mitigate counterparty risk by maintaining a matched book and risk-neutral position. You do not have to worry about the other end of your trade falling through, because CME Clearing is always on the other end.

CME Clearing continually enhances its services and safeguards to best serve the evolving listed (exchange-traded), and over-the-counter (OTC) markets. We provide a set of flexible clearing services that accommodate existing market structures for Interest Rates, Agriculture, Energy, Equity Index, Foreign Exchange (FX), Weather, Real Estate and Metal products, along with OTC instruments, e.g. FX non-deliverable forwards (NDFs) and Interest Rate Swaps (IRS).

With a wide range of customers who use our markets, each finds security in CME Clearing as an industry leader. CME Clearing maintains a risk management framework and financial safeguards to provide stability to market participants though changing market conditions.

CME Clearing financial safeguards are designed to:

Estimate potential market exposures
Prevent the accumulation of losses
Manage concentration risk among clearing members
Closely monitor the financial integrity and capability of clearing members
Ensure that sufficient resources are available to cover future obligations
Result in the prompt detection of financial and operational weaknesses
Allow for swift and appropriate action to rectify any financial problems and protect market participants

Policies and Safeguards

CME Clearing has evolved its proven risk management policies and financial safeguards to meet the demands of the marketplace, including the growing OTC market, providing a solution that:

Complements existing trade execution systems
Clears an extensive and expanding product line
Offers risk management efficiencies, including portfolio margining
Provides risk management tools such as pre-trade credit controls that allow clearing firms to limit the positions taken on by any specific customer

The resulting centrally cleared environment brings many benefits to the marketplace, including transparency of market pricing, market metrics, risk management practices and financial safeguards. Since a central clearing counterparty guarantees the performance of all trades, there is neutrality to every transaction, with uniform risk management standards.

Clearing Members

Clearing members provide access to CME Clearing for customers and must be registered as a Futures Commission Merchant (FCM). The FCM guarantees the financial obligations of the customer to CME. Collateral deposited by customers must be segregated from an FCM’s own funds.

Performance Bonds

CME Clearing collects performance bonds (initial margin) on a daily basis, collateralizing the risk of potential future losses on positions and performs daily mark-to-market of all open positions to eliminate the accumulation of debt obligations in the market.

Performance bonds are good-faith deposits to guaranty performance of open positions against potential future losses. Performance bond requirements provide coverage for a minimum of 99% of market volatility for a given historical period. Requirements are recalculated twice daily for most products, and at least once daily for all products.

Clearing members collect performance bond from their customers and CME Clearing collects performance bond from clearing members. Performance bond requirements vary by product and reflect changes in market volatility.

Mark-To-Market

Mark-to-market prevents the accumulation of exposures on positions. Clearing member positions are marked-to-market at each clearing cycle, resulting in the movement of cash for gains and losses on clearing member and customer portfolios.

Mark-to-market must be met with cash; however, performance bond requirements can be met with cash or non-cash collateral. To meet the needs of our clearing members and end-clients, CME Clearing accepts a diverse portfolio of assets as collateral for performance bond deposit.

If you have questions send us a message or schedule an online review .

Regards,
Peter Knight Advisor

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There are several ways for Commodity Trading Advisors to make money in the markets, but the two most common strategies fall under the categories of systematic and discretionary.

While the purpose of this lesson is not to discuss which strategy is superior, investors in managed futures should have a good understanding of these two leading strategies employed by CTAs.  Those new to managed futures should certainly comprehend the advantages and pit falls of each.  And, there are some CTAs that combine elements of both strategies!

Systematic CTAs

A systematic CTA usually makes trades based on models or computer programs.   These signals could be based on technical analysis using charts, trend following, momentum indicators, and stochastics.  Also, they could be derived from fundamental factors such as economic data like energy supply and demand, employment data etc.

A true systematic CTA will rely solely on the buy and sell signals generated by their computer model.  All human intervention and guess work or trading from the gut is eliminated.  Given that human emotions are susceptible to wide swings, trading off models keeps this issue at bay.  One of the complaints about systematic trading is that models usually need to be tweaked.    A system that appears to generate profitable signals in a high interest rate environment might not be as profitable in a low interest rate environment.  The same goes for low volatility vs. high volatility environments…which can play havoc with the best of models.

Discretionary CTAs.

Discretionary CTAs are nearly the exact opposite – trading decisions are made at the discretion of the portfolio manager.   Again, they can be based on fundamentals or technical, but a human is at the heart of the trading decision.  While the term “gut feeling” arises when talking about discretionary traders, most discretionary CTAs have very elaborate trading strategies based on solid research as well as very precisely defined risk management strategies.  But ultimately, all trading decisions lie with the traders.   As you can imagine this has pros and cons.    Unlike a model, the discretionary trader may at times let emotions get in the way.  This can lead to suboptimal results at times.

For example, during the financial crisis, the sense of panic caused many traders to make poor decisions.  But to be fair, there were models that didn’t work very well in a market panic too.

Neither strategy is fool proof – both can be profitable but can also generate losses.  This is part of the investment world.  There are CTAs with very long and successful track records in each category.

Can a CTA blend the two strategies?  Of course.  One thing about the financial markets is that they adapt over time.   A CTA could have many models they work with (the systematic component), but override final decisions at their discretions.  Or one could be a practitioner of discretionary strategies, but use computers to analyze fundamental and technical data (the systematic component).   It’s like the debate about fundamental analysis and technical analysis.  Can the two be blended?  Over the years a great many investors have had good success in the markets integrating both.

Comparison of the two strategies:

	Systematic	Discretionary
Models need to be reworked from time to time	Yes	No
Relies primarily on	Computerized models	Human decision making based on solid research.
Emotional swings	Largely non-existent	Yes and can play havoc
Required good technology	Yes	Less dependent on technology
Number of practitioners according to BarclayHedge	Over four hundred	Just over one hundred
Performance advantages	n/a	Slight performance advantages*

If you have questions send us a message or schedule an online review .

Regards,
Peter Knight Advisor

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Since the advent of investing, participants have always faced a dilemma: where, among the many asset classes, should an investor allocate their money. Layered on top of this important question are additional challenges facing the investor, like where to find global diversification, liquidity, non-correlation, transparency, and long and short strategies. Very few investments encompass all of these features, illustrated in figure 1 below. But managed futures satisfy many, if not all, of the prerequisites an investor needs.

Managed futures allow investment in nearly every asset class (private equity being the lone exception). Their globally diversified, liquid markets are non-correlated, highly regulated and transparent. Furthermore, futures are the easiest way to enact long/short strategies in many markets. These hallmarks provide compelling evidence for investing in managed futures.

Why Managed Futures

FACTOID: The growth of money flowing into managed futures over the past several decades has been truly spectacular. Managed futures had less than $10 million in Assets Under Management (AUM) in 1980. By mid-2017 however, AUM reached $343 billion.

Source: BarclayHedge

So why has so much money flowed into Managed futures? What are investors finding so compelling?

Diversification

Managed futures are an alternative asset class (say they are a strategy) that has achieved good performance in bull and bear markets. CTAs can combine professional management with a diverse portfolio of futures contracts to gain alpha.

Low Correlation

Managed futures exhibit low correlation to traditional assets such as stocks, bonds and real estate. When stocks or bonds head one direction, managed futures will often go a different direction. Managed futures allow exposure to markets that you cannot traditionally gain exposure to in the stock, bond or real estate markets, commodities are a primary example of this.

Reduce Overall Portfolio Volatility, Increased Returns

Managed futures and commodities, when used in conjunction with other traditional asset classes, may reduce risk and potentially increase returns.

Returns In Any Economic Environment

Managed futures provide returns in any economic environment and show strong performance during stock market declines. Managed futures may generate returns in bull and bear markets, boosting long-term track records despite economic downturns. Moreover, since managed futures portfolio managers (CTAs) can go long and short in all types of markets globally, they often do well in down markets due to short selling or options strategies

Successful Institutions Use Managed Futures

Pension plan sponsors, endowments and foundations have long used managed futures and have increased their allocations to the strategy significantly in recent years to help generate returns.

Access Liquid, Transparent Global Futures

There are hundreds of liquid futures products across the globe in interest rates, stock indexes, FX and commodities. A large portfolio of managed futures positions can be easily established or liquidated in moments if necessary.

Accessible to Nearly All Investors

You can choose from traditional, separately managed accounts from a CTA, managed futures mutual funds distributed through major brokerage firms as well as Exchange Traded Funds (ETF) that replicate managed futures strategies.

Highly Regulated

The CFTC and the NFA are the two major regulatory agencies involved in keeping the managed futures industry credible and trustworthy.

Risk Management and Clearing

CME Group and other exchanges around the globe practice sophisticated risk management protocols at their clearing houses to ensure the integrity of the futures markets on which CTAs trade. CME Clearing, our clearing houses attempts to ensure the performance of each and every contract on our exchanges and has done so for over 100 years.

Exceptional Industry Growth

As we pointed out earlier, growth has now reached $343 billion in AUM up from under $10 in 1980.

If you have questions send us a message or schedule an online review .

Regards,
Peter Knight Advisor

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Once an investor, whether it be a large institutional investor, a family office or a high net worth investor, decides to allocate funds to managed futures, they begin the process of due diligence. During this process, the investor will drill down to find out as much as possible about a Commodity Trading Advisor(CTA). The investor will want to know about returns, risk, length of track record, fees, investment strategy (systematic, discretionary) and dozens of other pertinent facts about the CTA. With large pension funds, allocations can run into the hundreds of millions (or higher) so you can imagine how particular and detailed this drill down can be. But even smaller investors will often want details about a particular CTA. The purpose of this module is to examine the basics of how to evaluate a CTA and his managed futures program.

Risk and Return

Many novice investors look at returns only. We are mesmerized by track records and all aim to obtain the greatest return possible. However, when more advanced investors do their homework, they also look at the risks taken to generate those returns.

We will compare two CTAs: CTA A and CTA B. Notice A generates consistent profits of between 12% and 14% over four years. CTA B has had a few years of stellar returns but also some large negative returns. Both CTAs grew the money to nearly identical sums; but CTA B did so with measurably greater volatility. His portfolio demonstrated substantial swings up and down evident of a volatile portfolio. Although CTA A took greater risk, he was not able to generate greater returns for his investors.

While some investors appreciate the wild ride in search of returns, others wish to reduce volatility in their investments. Investors with CTA B were not adequately compensated for the increased risk. When you take larger risks, you should generally be compensated with greater returns. In the investment world, you want the greatest returns consistent with the lowest risk. CTA A thus compares more favorably.

	CTA-A	CTA-B
Starting portfolio Value	$1,000	$1,000
Year one performance	12.4%	25.0%
Year two performance	13.9%	90.0%
Year three performance	13.2%	-20.0%
Year four performance	14.0%	-13.0%
Ending portfolio value	$1,652	$1,653

Sharpe Ratio

The Sharpe Ratio is a measure for calculating risk-adjusted return and has become the industry standard for such calculations. It was developed by Nobel laureate William Sharpe. The Sharpe Ratio is the average return earned (i.e. returns in excess of risk free returns) per unit of volatility or total risk. Volatility is generally measured using standard deviation.

Sharpe Ratio = Return – Risk free return/standard deviation

In our CTA example above, CTA B would have a lower Sharpe Ratio than CTA A because of the large volatility, yet identical returns. You are penalized for taking greater risks yet failing to achieve commensurate returns.

The greater the Sharpe Ratio, the greater the risk–adjusted return; investors would like to see this number as high as possible. Usually, a Sharpe Ratio of 1.0 or greater is considered to be good and implies that for every unit of risk you assume, you achieve an equal amount of return. In short, the larger the Sharpe Ratio the better. Negative Sharpe Ratios are also possible.

In the absence of additional information, a Sharpe Ratio alone is not as informative. But its becomes more useful when you compare the Sharpe Ratios of several CTAs.

Drawdowns, Depth of Drawdown and Recovery

Another critical item investors look at with managed futures accounts is drawdowns, which are the peak to valley performance of a managed futures account.

Since most CTAs report their performance numbers monthly, investors can look to see the largest losses or drawdowns in any given month. Investors can also look well beyond the drawdowns themselves. They look for length of drawdown: is it just one month, or several months?

They also look for the amount of time need to recover from a drawdown. Ideally you want small, infrequent drawdowns with quick recovery times. A general rule practiced by investors is to have drawdowns representing no more than 50% of the CTAs annualized returns. So, if a CTA obtains 20% annualized returns over time, you would want to see no more than a 10% drawdown in any given month.

Moreover, some investors require greater detail on drawdowns and want information on daily drawdowns.

For example, say a CTA shows a monthly drawdown of 10%. While that gives you some information, it does not let you know how things are going day-to-day. CTAs that take great risks might have drawdowns intra month of far greater than 10%, but you could not glean this from a monthly drawdown report and would need daily data.

Digging Beyond Returns

Looking at the diagram below, you can see a comparison of returns, risk (standard deviation), Sharpe Ratios and drawdowns.

10 Year Annualized Returns	17.54%
Std Deviation	13.98%
Sharpe Ratio	0.89
Max Monthly Drawdown	9.47%
Max Drawdown	12.71%

10 Year Annualized Returns	17.91%
Std Deviation	31.22
Sharpe Ratio	0.44
Max Monthly Drawdown	19.88%
Max Drawdown	30.07%

Notice, both CTAs have very similar 10-year returns. But the risk (as measured by standard deviation) of CTA 2 is substantially higher than CTA 1. CTA 2 took 2.5 times the risk, but achieved a mere 37 more basis points of return than CTA 1. Clearly, investors with CTA 2 were not compensated with higher returns, making the Sharpe ratio for CTA 2 is much lower than CTA 1.

In addition, consistent with higher risk are higher drawdowns. With CTA 2, the drawdowns are substantial (more than twice CTA 1) and are greater than 50% of the annualized returns; a rule many investors do not like to see violated.

In Summary

Sophisticated investors look well beyond returns on an investment to see what risks are taken to generate those returns, the Sharpe Ratio compared with other CTAs and how steep drawdowns are in relationship to annualized returns.
While there are many other elements that go into choosing a CTA, these make for a solid start. The topic of due diligence is vast and investors, especially institutional investors, will take months, if not longer, investigating a potential CTA candidate for investment.

If you have questions send us a message or schedule an online review .

Regards,
Peter Knight Advisor

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