Trend Trading: Two Decades of World-Beating Performance With No Market Correlation
An Investment U White Paper Report: Part 1
By Eric Roseman, Oxford Club Advisory Panelist; Editor, The Commodity Trend Alert
What if I told you there’s an investment that can produce super long-term returns without any correlations to stocks and bonds?
What if that investment had produced an average gain of 15.5% per annum since 1983 with only three modest calendar-year losses? And what if this same investment made stunning bear market returns in 1987, 1990 and even during the worst three-year market in a generation, from 2000 to 2002?
The fact that one investment offers all of the above to investors almost seems unreal. But it’s not. That one investment is “managed futures,” and within that class is a discipline called trend trading, which is the subject of the following white paper.
First, Some Background on Managed Futures…
Pioneered by legendary American trading wizards in the late 1960s, managed futures have evolved into a moneymaking machine, producing huge profits virtually every single year.
Managed futures, in fact, are similar to a Formula One race car. Their performance is sleek, extremely fast and exciting, with very few negative surprises once the program starts gaining speed. Managed futures offer no correlations to traditional assets such as stocks and bonds.
And while also presenting higher risks and fees than stocks and bonds, managed futures’ returns are ultimately nothing short of exhilarating – typically in the 25% to 35% range over a five-year cycle, depending on your risk adversity.
One must remember, however, that the driver is the most important part of your trip around the investment track.
Without the right driver, your managed futures program may not perform up to speed or may not generate the returns you need over time, particularly amid a bear market. That’s why this white paper report will spotlight the “best drivers” in the managed futures industry from a universe of more than 1,000 options.
You’ll learn which drivers, or Commodity Trading Advisors (CTAs), have led the industry over the last five and 10 years with brilliant returns despite several stock market crashes, corrections and international crises. Bull or bear, these guys don’t care.
Turtles for the Millennium: A Trend Trading Strategy
During 1984 and 1985, Richard Dennis, principal of Chicago-based Richard J. Dennis & Company, placed newspaper ads in several U.S. cities seeking trader trainees. Ads were placed in The Wall Street Journal, Barron’s and The New York Times. Students had to be willing to relocate to Chicago in return for a small salary and a percentage of trading profits, if any were even made.
The whole “Turtle” industry (a subgroup within the trend trading category) was born on a bet that Dennis had made with his trading partner, William Eckhardt. Dennis bet that anyone with a modest mathematics background could learn to trade futures using the Turtle trend trading system.
Eckhardt disagreed and accepted the bet. Dennis strongly believed that trading abilities could be broken down into a set of rules that could be passed onto others. Eckhardt believed trading abilities had more to do with innate instincts and could not be taught. A total of 23 young trainees were hired and trained in proprietary trading methods during a two-week seminar.
Dennis pondered: “Could the skills of a successful trader be learned? Or, are they innate, some sort of sixth sense that only a lucky few are born with?”
Results and Conclusions
After 18 months of training, the top 14 student traders gained an average compound return of 80%.
In contrast, about 70% of all non-professional traders lose money on a yearly basis. Dennis found out that the Turtle trend trading approach could be learned and applied by the average trader with successful results and minimal leverage!
Therefore, Dennis was able to start with only $400 and subsequently make more than $200 million in 18 years using the Turtle trading strategy. Dennis won his bet and much more!
Dennis’ top student in 1985 was Jerry Parker, Jr., an accountant by profession, who finished with spectacular results. Today, Jerry Parker is the president and CEO of one of America’s largest and most successful Turtle companies, Chesapeake Capital Corporation. Parker’s Diversified Trading Program has gained 20% per annum since 1988 with no losing years.
Where Turtles Stand Today
Turtles now represent a large portion of the trend trading managed futures industry. Many traders actually are coined trend traders, or “trend followers,” a derivative of the original Turtle school pioneered by Richard Dennis.
If you’re looking for the perfect alternative investment, offering non-correlation to stocks and bonds, then managed futures are the way to go. Especially in today’s mega-expensive stock market, a well-managed futures fund can boost profits even in adverse market conditions.
As you’ll see further in our special report, Commodity Trading Advisors (CTAs) earned staggering returns even in the market meltdowns of 1987, 1990, August 1998, and through the worst 36-month period for common stocks since the 1930s (2000-2002).
Let me add, however, that managed futures are certainly not for everyone. High investment minimums, expensive fee structures and poor liquidity features make this asset class a choice only for the aggressive.
These investors need to be willing to sit through periodic drawdowns, or declines, ranging from as little as 5% to over 15% per month. Volatility is always a prevalent theme with CTAs. If you don’t have the stomach for volatility or the bucks to meet the usually high minimum-investment requirements, then avoid the sector altogether.
But for the more experienced investor, the managed futures industry has earned its stripes in previous stock market meltdowns over the last 15 years, protecting portfolios from huge losses, and in some cases, even producing spectacular returns when just about everything else under the sun collapsed.
The top Commodity Trading Advisors have earned an average 25% per annum; many have never suffered more than one losing year out of the last 10 years – far better than even index funds or managed equity funds!
The Industry – Good and Bad
CTAs, also known as managed futures traders, appeared more than 30 years ago in the United States and today include over 550 independent traders worldwide – managing in excess of $50 billion in assets.
Some of the world’s largest multinationals use managed futures traders for their enormous pension-fund assets, including Intel, General Electric and IBM.
Be cautious, however. The managed futures industry is still represented by dozens of smaller, inexperienced traders with insufficient sums of capital to trade effectively. Like the average hedge-fund trader, the typical futures advisor is heavily leveraged, inexperienced, extremely volatile and even perhaps rogue.
Yet one segment of the mutual funds industry remains among the most profitable in rising and declining markets – Commodity Trading Advisors.
How Trend Trading CTAs Work… And Work for You
Commodity Trading Advisors are registered with the National Futures Association (NFA) and the Commodity Futures Trading Commission (CFTC). CTAs are also registered as CPOs, or Commodity Pool Operators.
The CTA trend trading approach is set forth in an algorithmic or mechanical manner. Futures and options trades are based on a rigorous trend following system, whereby more than 100 options and futures contracts are traded worldwide, and in most cases, 24 hours per day.
The important thing we need to learn is how a trend trading system, or trend following system, manages risk. Trend traders don’t make hugely leveraged macroeconomic bets on global trends. Rather, they use a strict diversification discipline that employs small positions.
As trades become increasingly profitable matched by a rising trend, the trader typically raises his stakes as the trend becomes even friendlier. Alternatively, as the trend changes to the downside, traders gradually withdraw from the losing position until the trade is closed.
The challenge for traders is dealing with a trendless market. During these periods, the trading advisor will become defensive to reduce losses and conserve capital.
The following chart is a composite of the global futures and options contracts traded by most Commodity Trading Advisors, 24 hours per day around the world:
Markets Traded by CTAs:
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Currencies Metals Grains & Meats U.S. Dollars Gold Corn Australian Dollars Silver Soybeans Canadian Dollars Copper Bean Meal Euros Tin Bean Oil Swiss Francs Lead Cattle British Pounds Zinc Hogs Japanese Yen Aluminum |
Wheat U.S. Dollar Index Platinum Pork Bellies Stock Indexes Interest Rates Energies S&P Index U.S. T-bonds Light Crude Oil NYSE Index U.S. 10-year Notes Natural Gas FTSE-100
NY Unleaded Gas Nikkei Index Eurodollars |
German DAX Euro Stoxx
Tropicals Sugar Australian Treasury Bonds New Cocoa ? Australian Bank Bills French Bonds Coffee Cotton Robusta Coffee Euro Swiss French 3-month Pibors Japanese Gov’t Bonds Frozen Orange Juice German Bunds Long Gilt (UK) Lumber Italian Bonds Euro Futures 3-month Interest |
How To Employ Trend Trading: The Technique
Many, but not all, CTAs, are trend-following traders by definition. Some CTAs trade discretionary programs where fundamental analysis on government crop reports, weather patterns and hunches serve as the backbone for that CTA’s trading style.
Trend trading followers, on the other hand, don’t make hunches or trade on government data. They strictly trade on price patterns based on computer-guided models.
Trend trading methods seek to recognize major gains by participating in significant price movements. A trend follower’s basic approach is to limit the losses incurred on his more numerous losing trades, while attempting to recognize sufficient profits on major movements that he correctly identifies.
In contrast, most conventional or discretionary-based traders place big bets on several trends while incurring above-average volatility and suffering numerous drawdowns in the process.
The trend trading techniques are 100% “systematic.” Trend following does not involve seasonal trading patterns, market profiles, triangles, fundamental analysis or day trading. Rather, trend following trading is rooted in risk control and diversification.
All math is straightforward and easily learned. The beauty of this system is that it is Turtle-like, not based on the emotions or quick hunches of the trader. It disciplines the trader in both up and down market cycles.
Trend followers accept tendencies as confirmation of some direction. If a direction continues, traders add to their positions aggressively in a systematic, rigid manner.
CTAs – Outperforming Other Assets by Quite a Margin
The following table compares three investment periods and five independent and non-correlated asset classes. Generally, alternative funds, which include managed futures and hedge funds, have fared quite well versus stocks and bonds in all periods, except in the period from 1992 to 1996.
| INVESTMENT TYPE | 1982-86 | 1987-91 | 1992-96 |
| 90-Day T-bills | 8.86% | 6.86% | 4.35% |
| U.S. Gov’t Bonds | 16.88% | 9.40% | 6.87% |
| S&P 500 Index | 19.87% | 15.33% | 15.19% |
| Hedge Funds | 24.19% | 19.89% | 9.00% |
| CTAs | 25.96% | 20.88% | 8.08% |
| Source: Managed Account Reports | |||
Although stocks have done very well since 1991, most Commodity Trading Advisors have lagged behind. There are exceptions, of course, and the world’s top CTAs since the 1990s and 1980s have nevertheless earned market-beating returns.
In fact, most have even outpaced the high-flying S&P 500 Index since 1994, while more importantly, posting net profits during severe market declines.
Why CTAs Can Be Less Risky Than Hedge Funds
Based on the previous table, CTAs beat stocks and bonds from 1982-1986 and once again from 1987-1991. Hedge funds also fared well over this time frame, but are a different breed of alternative trading vehicle and generally performed poorly from 1994 to 1998, depending on the underlying strategy.
Some hedge funds, unlike CTAs, make massive directional leveraged bets around the world and can earn stunning returns when they call the trend right.
These decisions, however, are not technically based (like trend trading decisions are), but instead, based upon fundamental hunches or bets on international markets.
In 1998, many hedge funds were clobbered by leveraged bets in U.S. junk bonds, Russian GKOs (T-bills) and emerging-market debt.
CTAs, on the other hand, gained 4.9% in August 1998 as world markets crashed, according to the MAR Hedge CISDM Fund/Pool Qualified Fund Index. At that time the average hedge fund lost more than 5%.
The fact is, under extreme market circumstances, the best CTAs are far more profitable than hedge funds since they thrive on market volatility. Hedge funds trade on hunches. Trend traders, on the other hand, use a disciplined trading system that minimizes risk.
Again, there are no emotions involved with this approach. Risk is also diversified, whereas a hedge fund will typically allocate a large portion of a portfolio to one security or one country with too much leverage.
Expansion, Economic Cycles and When CTAs Earn the Most
CTAs tend to earn spectacular profits at the emergence of an economic cycle, or during expansion, such as in the years 1991 to 1993.
Additionally, they tend to log substantial returns at the end of an economic expansion, particularly during recessions, most recently in 1990-1991 and the 2000-2002 bear market. This is because trends have a tendency to become extremely volatile at economic peaks or junctions.
For example…
- In 1990, the United States suffered a soft recession, exacerbated by the Gulf War. As the world’s major economies started to slow down, the demand for raw materials ebbed, resulting in huge short-sale trends for most tangibles, except oil.
- Bonds in 1990 also rallied, providing profits for trend traders, while global stocks plunged, resulting in additional short-sale gains.
- Along with other U.S. financial assets in 1990, the dollar sharply declined against European currencies. The average CTA in 1990 earned 27.3% versus a 3% loss for the S&P 500 and a 17% loss for the MSCI World Index.
- In 2002, the worst calendar year for U.S. stocks since 1974, the median CTA gained 12.1% versus a crushing loss of 22% for the S&P 500 Index and -21% for the MSCI World Index. Trends, however, were maximized by CTAs as bond yields plunged, the U.S. dollar declined, and stock indexes tanked.
In fact, from January 2000 through December 2002, the average U.S. domestic stock fund shed over 35% while some of the top-performing CTAs gained 50-100%!
CTAs can earn big profits in any economic cycle, unlike stocks and bonds, which require different economic conditions to prosper. One could even argue that as economic changes become more pervasive – expansion or contraction – the trend trading approach can result in even greater net profits.
Bull or bear, CTAs don’t care. The more identifiable the trend, the greater the profit.
Good investing,
Eric Roseman
P.S. I encourage you to sign up for the free, three-times weekly Investment U E-Letter, headed up by renowned economist and best-selling author Dr. Mark Skousen. It’s full of actionable investing wisdom you can put to use right away to become a better investor.
Move on to Trend Trading, Part 2: Turtle Trading and Trend Following
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