What It Takes To Be Successful In Commodity Trading

By: Andrew_Abraham

I am lucky to have a colleague who has been in the field of commodity trading since 1980. This is what every trader needs. A mentor.. a person of experience… Charles Maley is just that. Charles started in the business in 1980 when he joined PaineWebber Jackson Curtis, Inc. Charles has 29 years experience in the field. He was immediately introduced to quantified mechanical trading systems under the guidance of Jack Schwager, then head of research.

Both Martin and Charles continued their research until they moved on to Oppenheimer/CIBC in 1983. Charles spent the next 10 years with Oppenheimer in trading and sales before C0-managing a derivative desk for Bank Julius Baer in New York. He then joined Angus Jackson and re-united with Martin Bedick in 1998. His vast and long experience in trading has been the strength of the trading programs and methodologies used at Angus Jackson. Charles focuses on Angus Jackson’s continual research and growth.

I want to share you a recent interview Charles gave Traders World. Charles knows what it takes to be successful in the field of commodity trading. Read and learn what it really takes if you want to be successful in commodity trading.

What is your position with Angus Jackson and how long have you worked there?

Martin Bedick, the main principal at Angus Jackson, encouraged me to join the firm in December of 1998. The idea was to grow Angus Jackson behind the concept of trading with mechanical systems and sound money management. My position today would best be described as working with corporate and individual accounts, helping them trade commodities by providing them with a sound trading plan.

How long have you been using Mechanical Systems?

Martin and I started together over 25 years ago at Paine Webber, when Jack Schwager was the director of research. Jack and a fellow named Norm Strom were using mechanical systems to trade a Paine Webber product back in 1981. Not only was this my introduction to using mechanical systems, but at the time it was one of the few mechanically traded funds in existence.

What is good and what is bad about using Mechanical Systems?

There is an overwhelming amount of information available today and a trader needs a way to organize this information. A mechanical approach will define specific conditions that present opportunity and specific conditions where that opportunity fails. Mark Douglas in his book The Disciplined Trader said mechanical systems mathematically define and quantify past relationships to give you a probable outcome.

On the other hand a mechanical system can lure you into a false sense of security. Quantifying past relationships to project a statistical success is not the same as quantifying the future. In real world trading, because of the limitations of back testing, you will at best achieve a likeness to your statistical probabilities. If your program is not actively managing exposures you are headed for trouble. Staying disciplined with a system that the real world has compromised is a recipe for disaster.

Which systems do you use with your clients?

Angus Jackson is primarily an advocate of trend following systems. We work with a handful of system developers and programmers that we have had strong relationships with over the years. Our approach is to consult with the client in terms of available capital and expectation for risk/reward and then guide them into an appropriate model. Mostly we use models that incorporate multiple trading systems and multiple risk management strategies.

Which is your favorite system and why? In your opinion, which are best ones to use today?

We don’t necessarily have a favorite system but we do have a favorite approach. Once again Angus Jackson is primarily a trend following firm. However, there are some significant changes going on in the commodities markets. When I started in the business CTA’s managed less than 1 billion in assets. In 2002 it was around 40 billion. In the last three to four years it has ballooned close to 150 billion. This has caused us to re-think traditional trend following. We now think more along the lines of capturing the trend because they are so much faster and shorter in duration. We try to capture some part of the move as opposed to following it all the way out. We do this by using multiple systems and more aggressive exiting.

Can you explain how you use the favorite systems with your clients from start to end.

First we run the multiple trend systems over a basket of 65+ markets. We are constantly monitoring markets for liquidity and do not want to trade any markets that have poor liquidity. Since we generate a fair amount of trades we have the ability to filter for an acceptable risk/reward profile, and then select the trades that are best suitable for the portfolio. It is an attempt to participate in some of the advantages of a large diversified account. We attempt to keep leverage and volatility down yet we have opportunity across many markets.

How is money management used?

All signals generated by the systems are required to pass through the risk and money management filters. This allows the program to examine risk prior to selecting the trades for the account. Each trade has to meet a certain criteria to ensure that no one trade can adversely impact the program.

In addition, the program also monitors the portfolio for the amount of risk that it will accept in each market group. The markets that make up each group are highly correlated and this protects against too much exposure in any one sector. Finally, the program manages the total risk of the account by monitoring the amount of exposure in all the open positions. This protects the capital against a random event that could cause ruin.

Do you do anything to improve the systems you use?

We do not try to improve the systems, but we employ a common sense approach to managing them. When a trader runs a program the computer can only report back what was programmed. Real world trading has a way of finding limitations to any back test. We call the back test The “One-eyed King” because in the real world, randomness plays a much stronger role than we would care to believe. Ignoring the role of randomness could lead us to think that we have quantified the future. Therefore we spend a fair amount of time looking for things the computer can’t tell us.

How are signals executed and what is different the way you do it and the public using one of these mechanical systems.

Our signals are executed through our in house traders who have extensive floor experience. I would say we are much more cognizant of slippage and how it negatively impacts performance. Also due to the amount of contracts we trade we have established relationships with floor traders, arbitrage lines, CTA desks etc., all over the world to enhance our execution and control risk.

In your opinion what percentage of available trading money is used by mechanical systems?

The percentage of money that is being traded by mechanical systems would be impossible to know. According to Barclays there is close to 150 billion managed by Commodity Trading Advisors. I would speculate that a fair percentage of them use mechanical models either exclusively or with some discretion. However, there are some 68 commodity oriented hedge funds according to The Daily Wealth News Letter, and hedge funds rarely disclose information about their techniques or positions. Also, there is a large amount of commodity linked products in the form of derivatives that may or may not be mechanically traded.

As someone in the business as long as you have been, can you tell me why some are successful and others fail at trading?

I think successful traders realize a few important things that escape the failures. It doesn’t seem to matter if they trade discretionary or with systems, they all seem to know that the market is the boss. They are defensive and have a great deal of respect for risk. They all tend to manage risk and let reward take care of itself. The failures are for the most part completely focused on the reward, usually at the expense of risk.

Also successful traders share similar attitudes toward expectation for reward. They, for the most part, believe there is a risk premium over the hedger that is available to the speculator. They are also well aware that they are not entitled to it, only that it is available. Second, they believe that the rate of return is tied to the cost of money. Finally, they view their jobs to be a long term process to obtain that return without risking a drawdown beyond what they can handle, or the random risk of ruin. The failures tend to think there are returns consistently available at the higher levels of 50 and 60%. Unfortunately they find out the hard way that they must be more realistic to survive.

Any recommendations to our subscribers as how to be successful at trading?

There is nothing magical that I can share with your readers. The reality is that trading is one of the most challenging endeavors that you will ever undertake. Get a precise logical plan. The logic behind the method you choose is critical. It is impossible to trust the interpretation of past data where logic is absent. Then proceed with realistic expectations, understanding that you will encounter more obstacles than you might imagine. Accept the real risk. Previous draw downs are simply a statistical guideline to potential risk and not the true risk. True acceptance of risk means you know you can lose your money. The good news is that this freedom should allow you now to think in probabilities as opposed to being driven by emotion. Also seek help. Get smart people around you. Get aligned with other traders or a firm that can help you work on these concepts.

Andrew Abraham
www.myinvestorsplace.com

Andrew Abraham has been in the financial arena since 1990. He is a commodity trading ddvisor and co manager of a Commodity Pool. Since 1993 Andrew has been a proponent of quantitative mechanical trading programs. Andrew's major concern is not only total return on investment but rather the amount of risk that one would have to tolerate in order to achieve returns He focuses on developing quant models that encompass strict risk adherence and correlation. He has been a speaker at conferences as well as an author of numerous articles. Andrew has spent years researching ideas that have the potential to outperform indices as well as maintain fewer draw downs.

Visit Angus Jackson Partners (http://www.angusjacksonpartners.com) Contact: A.Abraham@AngusJackson.com (mailto:A.Abraham@AngusJackson.com)

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