Most professional CTA’s look and think about trading much differently than an average trader or investor would, and the reason for this is not hard to understand. If a CTA is successful, they have dedicated their lives to the craft. Every trader wants to be successful; the subtle difference with a profitable CTA is that they need to be successful; this is their livelihood. Therefore, they are willing to spend every waking hour learning their craft, testing and back-testing new systems, methodologies, and philosophies; this takes a lot of time. Think of it this way, if you had to go to court to defend yourself on a matter that would affect your life indefinitely, would you represent yourself “Pro Se? If you knew all the ins and outs (tricks of the trade) of

the “law,” then you possibly could consider it, however, what most people overlook would be the amount of time and mental energy this endeavor would cause you to undertake, not to mention the stress and sleepless nights. Even if you did know “the law” and felt you were right, if you were to go up against a proficient lawyer who knew the “market,” the judges, how the game is played, but more importantly, that his whole professional life revolves around knowing his business and spending probably 14 hours a day or more practicing it, not to mention having a staff, and a pool of resources (that you don’t), to “Win,” you would probably reconsider going it alone unless you wanted to spend the rest of your life being a “professional defendant. This is an excellent metaphor for a profitable CTA, in my opinion, for the reasons given above.

Here are the Six Key Variables a CTA knows that you may not know. I will cover 3 of them in this article and the other 3 in a follow-up.

#1. Knowing the reliability or what percentage of the time your trades make money.

For example, if a CTA were to make ten trades (I recommend using a more extensive data sample), and they made money on 6 of them and lost on 4, then their reliability would be 60 percent. To compute reliability, it is the number of winning trades divided by the total number of trades. Some CTAs may refer to reliability as the “hit rate.” It is the percentage of time their trading system is “right.”

#2. How big your portfolio (risk capital), is compared with your losses

…(when traded at the smallest possible increment (ex: one futures contract). The relative size of your profits and losses would be the same if you lost 1 point in the S&P on losing trades and made 1 point in the S&P on winning trades. However, the “relative size” would be quite a different story if you made, on average, 10 points on winning trades and lost 1 point on losing trades. This would be 10 to 1.

CTA’s can get a good ratio of the relative size of their profits to their losses by taking the average size of their winning trades and comparing that to the average size of their losing trades. This will give them a good idea of “relative size”; however, this would not be an exact measure if they have one huge profit and many small losses.

A more exact measure is to consider gains multiples of the “Initial Risk” (R) you took on that trade. Your gains may then be a whole series of R multiples. For example, let’s say you are willing to risk $1000 on a trade (you will exit immediately if you have a $1000 loss, so it doesn’t increase). Your basic risk is $1000. Therefore, a $2000 gain would be a 2-R multiple gain, and a $5000 gain would be a 5-R multiple gain. If some unfortunate event in the marketplace occurred and you suffered a $2000 loss, you’d have a 2-R loss.

#3. The cost of making a trade.

This is the erosion that occurs to a CTA’s account size whenever they trade due to execution costs, fees, and commissions, also slippage. CTA’s usually include these costs when figuring their average gains and average losses. However, it is wise to know just how significant these costs are. They add up quickly, especially with a higher frequency of trades made. Expenses and fees have decreased over the years but are still a factor.

As I said above, these are 3 of the six key variables a CTA or professional manager knows and focuses on that you may not. If you have any questions, please feel free to contact us; you can email me directly at or call anytime:  312-561-3145.

I will follow up tomorrow with the next three key variables.