Q&A

Futures For You

with Carley Garner

Inside The Futures World
Want to find out how the futures markets really work? DeCarley Trading senior analyst and broker Carley Garner responds to your questions about today’s futures markets. To submit a question, post your question at https://Message-Boards.Traders.com. Answers will be posted there, and selected questions will appear in a future issue of S&C.

As An Independent Trader
I am currently trading with my own money on futures (commodities, indexes, interest rates, currencies, for about 10 years) and would like to start trading with larger accounts. My performance over the last year is a Sharpe ratio of 2.75. What steps should I take to find funds that could be interested in using me as an independent trader? —Michel in Belgium

If you feel as though your futures and option trading ability may be attractive to investors who don’t have the time or the skills to trade their own account, you may want to consider becoming a Commodity Trading Advisor (Cta). Registering with the Commodity Futures Trading Commission (Cftc), along with becoming a National Futures Association (Nfa) member, gives you the ability to manage money for US clients on a fee basis. If your intention isn’t to accept US clients, Nfa and Cftc registration isn’t necessary, but it is recommended if you are trading on US exchanges. I am unfamiliar with any regulatory obligations in Belgium, but you would certainly want to ensure that you are operating within the rules.

Once properly registered, you will need to create a disclosure document. This document will contain the details of the agreement between you (the trader) and your clients such as the risks in participating in the program, the fee structure, and any historical performance data. The disclosure document must then be submitted to the Nfa for approval; upon the Nfa’s consent, you are free to begin soliciting clients — that’s the hard part.

Finding willing and able participants in your trading program isn’t as easy as it may seem. Don’t get me wrong; even in a down economy, there is a lot of money looking for a home. However, in a post–Bernard Madoff world, investors are (rightfully) skeptical of programs that show too much or too little profit. In addition, programs with relatively short trading histories can be difficult to raise money for. Based on my conversations with retail investors and others in the industry, it seems as though investors are looking for a two- to three-year track record before they can justify allocating funds to a program.

It is important for a Cta to be seen. You will want to register with reputable, and of course regulatory-compliant, Cta rating firms and/or Fcms (Futures Commission Merchants). Such firms compile the data of currently active Ctas so that investors can locate trading programs that fit their needs in terms of potential risks, rewards, and strategy. Visitors or members to the service are able to browse Ctas that fit a specific Sharpe ratio or minimum drawdown criteria.

While making your services known is important, it will take time for your trading program to build trust within the trading community. If you are successful in doing this, it may all be worth it.

I do not intend to deter you from pursuing your dreams. Being a Cta or money manager can be a lucrative and emotionally rewarding occupation, assuming you trade profitably. I just want to provide you with a candid look at the realities of getting started and provide a realistic time horizon for potential success.

Restricting Speculation
I have heard that the Cftc is looking to restrict speculation in commodities. Is this true?

While the story hasn’t gotten the news coverage in 2009 that it did in 2008 as crude oil was peaking at near $150 per barrel, the issue is still alive and well. Although they resisted pressure by lawmakers last year to limit speculation in crude oil, the Cftc is currently exploring the idea of doing just that.

Many fear that once the ball gets rolling, it will be difficult to stop. If the Cftc decides to move forward, the policy may eventually bleed into other commodity markets. Who knows? The Financial Industry Regulatory Authority (Finra) and the Securities and Exchange Commission (Sec) may eventually follow in the footsteps of the Cftc by adopting a policy aimed at cracking down on stock market speculation.

Clearly, there are arguments on both sides of the issue. Nonetheless, speculation is a zero-sum game. Aside from brokerage firms and exchanges who stand to make money on each executed trade, for every speculator who makes money there is one who loses it. The risk of capital alone acts as an internal market regulator to some extent. Those who have been on the wrong side of a commodity market are typically hesitant to get back into the game.

In addition, while domestic commodity exchanges dominate the global marketplace, traders do have alternatives. The unintended consequence of limiting traders on US exchanges will likely be a shift in liquidity and market viability overseas.

I will not deny that in the short term, excessive speculation can increase the magnitude of any given price move; that became painfully obvious in 2008, but limiting speculation may not be the solution. If speculators move to overseas exchanges, price “manipulation” will still exist, but the vibrant domestic futures industry that the rest of the world envies may not. Further, it was speculation that allowed crude oil to fall more than $100 per barrel from its high, and neither consumers nor lawmakers had a problem with that.

On the other hand, extreme price swings wreak havoc on individuals, commerce, and of course the economy as a whole; we could certainly do without them. Unfortunately, we don’t live in a perfect world and there doesn’t seem to be a clear-cut solution, or at least one that wouldn’t create alternative problems. One thing is for sure: this debate will be ongoing, and the impact will be significant for commodity traders as well as the average citizen.

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