Using Added Leverage With A Managed Futures Account
Any time an trader looks at the performance of a trading system or Commodity Trading Advisor
, one of the most important statistics is what the needed minimal account size is. It makes no sense contemplating trading systems or managed futures that have $100,000 minimums if the investor only has $50,000 to invest.
However, it is valuable to know that frequently the investor can begin with much less than the minimum via notional funding. For instance, an investor could notionally fund a
managed futures or trading systems account at the $50,000 level yet tell the manager to trade at a nominal $100,000 amount. In other words, the account will trade as though there were $100,000 in it even though there is not. The trader is merely making use of additional leverage.
In the prior example this means that the account will be trading at 2-to-1 leverage. Which means the trader will have gains and losses at twice the amount. Had the investor only put up a third of the nominal amount minimum then he would see increases and losses at 3 times the level and so on.
Why individuals using Trading Systems or Managed Futures May Want to Consider Notional Funding
Notional funding can easily be an efficient use of capital, since frequently a trading system or managed futures account will not come anywhere near to utilizing all the money in the account. For instance, in Hoffman Asset Management's case we have a margin-to-equity percentage of generally less than 10%. What this means is that for every $100,000 invested, typically speaking, we will be utilizing less than $10,000 at any given time for margin. The leftover $90,000 sits on the sidelines stagnant. While it is correct that interest on those untouched funds can be earned, most investor's feel they could do better investing those funds elsewhere. Often time's high net worth persons or corporations will even put NOTHING in their accounts and trade 100% notionally. The question for investors should be "how can I determine a realistic notional level to invest at".
We think the answer to that question is one that can be computed based on several statistics. Specifically, what is the largest drawdown expected and what is the highest margin that may be required. For example, Hoffman Asset Management (as of this writing) has had a maximum drawdown of about 17% on a $125,000 nominal account size. This indicates a $21,250 drawdown in cash terms. The greatest margin usage is about 15% on $125,000 or, about $18,750 in cash terms.
To calculate a notional investment amount, we recommend that an investor add the largest anticipated drawdown and the greatest expected margin usage. This number would provide the trader the absolute minimum they could invest in the account without getting a margin call.
In the previous example, if an trader had began on the worst possible day, and had a $21,250 drawdown, and simultaneously experienced the highest margin usage of $18,750, he would have required $40,000 of cash in the account to fund that $125,000 nominal account size. Once again, some organizations and persons who are not concerned about margin calls might even decide to fund the account with less than that (or zero).
Benefits to the Trading Systems or Managed Futures Investor
This allows the smaller, but more aggressive investor to get involved in the program without needing to tie up the entire amount in cash. This can amplify their gains and losses at the additional leverage amount they are utilizing. If, for instance, the manager made a 30% return with a 17% drawdown, then the trader at 2-to-1 leverage would have experienced 60% gains with a 34% drawdown.
Once again, this is a more aggressive strategy, and we recommend this only for traders who completely understand the advantages and risks of notional funding. However, for the right trader, this can be a beneficial tool to have in his or her arsenal.
Dean Hoffman - Hoffman Asset Management
Futures trading does carry risks and is not suitable for everyone. Past performance is not necessarily indicative of future performance.
Using Added Leverage With A Managed Futures Account
By: Dean Hoffman
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