Many people want to get into commodity trading but look askance at the vagaries of the markets and worry that they will lose a lot of money. Some individuals with limited trading experience can jump into the fray without losing their pocketbook; others aren’t so fortunate. Even some investors without experience investing in commodities may be shy at moving into the sector. Fortunately, there is a way for those with means to invest in the commodities market and perhaps come out better than they started most of the time. But they have to know the right tracks to follow.
If you have the funds necessary and want to trade in futures contracts, commodity options or swaps, your first step should be to find a Commodity Trading Advisor, or CTA. A CTA is an individual or organization hired by a fund or an individual client to provide advice and services for trading futures contracts.
There are many CTAs in the world so find out the investing pedigree of the one you chose. First, find out what kind of experience the CTA has in trading the markets. Even if they tell you they have this great system or model, find out how it works. Nothing is foolproof. As the digital age has infiltrated trading in the past two decades, the action has become more complicated. There is high frequency trading, which can jumble markets faster than lightning, there are “flash crashes” that can wreak havoc. More technological advances — and nightmares — are lurking out there in the marketplace. A successful CTA needs to be aware of all the things that go on in the markets and know how to deal with them. One of the more important aspects of a CTA is the return on margin they create for your account. One CTA may manage $1 million, using 50% to 60% margin and bring a 15% return. Another may generate almost the same return on the $1 million, but may be using only 5% to 15% of the margin. Look at the margin usage when you are building a portfolio. It is a high risk or high margin, low reward situation, you are better off looking at a CTA that is risking less and making more return. It is important to find a CTA that has the specialty in which you want to engage, whether it is trend following, options writing or the like. CTAs can be found in many ways, but it is good to deal with those with experience in the sectors in which you wish to trade. There are a lot of contracts to trade — energy, grains, metals, coffee, cocoa and sugar. It helps to have a CTA with on-the- ground knowledge of the different commodities.
Institutional Advisory Services Group, Inc., for example has about 700 CTAs in its data base with a good sample of trading in different modes such as options writing and trend following.
Allocation of the trading funds is also important. An investor with $500,000 might want to avoid putting the money into too many pots. If you are tempted to practice diversity and put $50,000 in one fund, $25,000 in another and so on, think twice. You may be better off dividing it up in bigger portions, such as $250,000 to one fund and a similar amount to another –even if the minimums are higher. You have to be careful with funds that have lower minimums such as $25,000. They may not have the pedigree, or they are new and seeking clients by using low minimums to attract business. They may have a track record that is erratic, or they may have blown out in other situations. As for the CTAs with higher minimums, they are typically seeking more sophisticated investors who are believed to have a better understanding of the risk/rewards of investing in Managed Futures.
IASG seeks to assist you through this process with our knowledge and expertise in the CTA space. We have extensive “first hand” experience advising client on asset allocation so comment and let us know how we can help you.