The Conundrum of Small Managed Futures Accounts

Article Written By: cheapmes@gmail.com

A large managed futures account does not have to shy away from any trading opportunities which may become available, even those whose volatility is fairly high. For example, a London copper trade with a stop loss $14,000 away represents a risk of only 1.4 percent in a million dollar managed account, but in a smaller managed account of only $100,000, this same trade would represent a risk of a whopping 14 percent!

With such a large risk, stemming from the small size of the account, any sensible trader would be forced to avoid this trade. Having to skip these types of opportunities is yet another penalty paid by the small managed futures account.

Let's assume, for example, that a trader has a large account which is long 50 gold contracts during a large bull market run and that they wish to cut their open trade profit exposure. To do this, they can simply scale out as many contracts as they need to lock in profit, all while maintaining their profitable position.

Now, despite all the negative points that I've just summarized above, I still believe that smaller accounts have advantages over large ones. Most institutionally sized funds are almost confined to the trading of financial and energy instruments. They end up missing out on trading opportunities afforded by the traditional physical commodity markets, specifically commodities like grains, foods and fibers. This creates a lack of diversification and an over reliance on those few sectors in which the large account can trade.

The ironic thing about it is that many small accounts end up with this same problem. This is because they have chosen to deal with their small account problem by only trading in a few markets. Some even confine themselves to just one market and so end up missing out on the greatest advantage they have over the "big boys."

The intent is to keep drawdowns and volatility in line with what has previously only been available with a large, widely diversified account. This combination of trading many markets within a small account while keeping volatility in check is truly unique. It fills what we feel is a tremendous void in traditional managed account offerings.

Although what we do is largely proprietary, the basic premise uses a form of relativity. HAMI monitors a large universe of tradable commodities for opportunities, yet is still highly selective in those trades that it will take. For roughly every 10 trading opportunities identified by combination of trading systems, it takes only 1.

Simply put, the idea is that an opportunity can only be evaluated relative to what else is available. For example, how does a trader know if a 5% return is acceptable or not? For a wise trader, the only acceptable answer is that it depends on what else is available. In other words, the acceptability of a 5% return can only be calculated based on the other relative options that are available. Only some of all the markets tracked by HAMI's strategy get identified as the best.

The portfolio selection process is dynamic and gets rebalanced every day. From day to day there are changes made to the basket of markets that we will consider trading. This keeps trades limited to only those markets that we feel have the best risk adjusted potential, and it allows us to evaluate a large portfolio while still keeping trades and margin requirements low.

Monitoring a large portfolio is key. If traders limit themselves to a predetermined small portfolio, how will they know that those markets are still the best markets? Hindsight bias portfolio selection is a form of curve fitting and is a leading downfall of many traders.

About the Author

Dean Hoffman. For more information about Hoffman Asset Management and its managed futures accounts please click the links.

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