Personal Investing Advice

The Small Futures Account Conundrum

I recently scanned a Commodity Trading Advisor Database to look at minimum account sizes and found minimum account sizes ranging from $25,000 to $5,000,000. I found the typical CTA trading a small minimum account size had a concentrated portfolio, high margin requirements, little money under management, a short track record, high volatility or was trading just options. Diversified trend followers seemed to have minimums that were usually at least $1 Million.

Small accounts in the futures markets (less than $250,000) face a considerable number of challenges not experienced by large accounts. Considering that most commodity futures contracts have face values in the tens or hundreds of thousands of dollars it’s easy to surmise that these contracts were designed for large accounts. However, low margin requirements have long attracted smaller speculators and have been the proverbial “rope to hang one self with”.

Let’s analyze why large accounts may have it easier than small accounts. First, large accounts can afford to trade virtually any opportunity at any time. There are over 100 tradable commodity markets worldwide, and should buy or sell opportunities simultaneously exist in any or all of them a large account can easily afford the margin and exposure to trade them all. It has been said that that when it comes to investing that “diversification is the only free lunch” and large accounts can afford to diversify with impunity. This is in stark contrast to the small account where prudence dictates only having risk and exposure in a limited number of markets simultaneously.

Furthermore, a large account is not restricted from trading contracts whose volatility is relatively high. For example, a London copper trade with a stop loss $14,000 away represents risk of 1.4% in a million dollar account. However, in a $100,000 account this same trade would represent risk of a whopping 14%! Of course any sensible trader would avoid that trade in such a small account; however, having to skip these opportunities is yet another penalty paid by the small account.

What’s more, the large account can utilize one of the easiest forms of risk control available, contract scaling. For example, let’s assume a large account is long 50 gold contracts during a large bull market run and wishes to reduce his open trade profit exposure. He can simply scale off however many contracts he needs in order to lock in profit, while simultaneously maintaining his profitable position. However, what can the small account do in terms of scaling out if he only has on one contract in the first place!? Once again, the small account does not enjoy the flexibility to control risk in the same fashion as the large account.

Now, for all of the negativity I’ve just outlined above I actually believe the smaller account can have a significant advantage over large ones. Small accounts are able to efficiently trade markets that would be far too illiquid for large accounts. Most institutional size funds are virtually confined to only trading financial and energy instruments and miss out on trading opportunities in the more traditional physical commodity markets. Specifically commodities like Grains, Foods, and Fibers etc. This creates a lack of diversification and an over reliance on those limited sectors. The ironic thing is that many small accounts end up with the same problem because they have chosen to deal with their small account problem by only trading a few (or one) market! They end up missing out on the sharpest edge they have on the “big boys”.

Fortunately, it is for those smaller traders who want the advantages of true global diversification that Hoffman Asset Management Inc. was formed. HAMI is carving out a unique niche by offering a trading program that monitors and trades over 70 diversified commodity markets, yet is designed to trade accounts as small as $125,000. Furthermore, the program has been designed to attempt to keep draw downs and volatility in line with what might be available in a very large widely diversified account*. This combination of trading a large number of markets within a small account while keeping volatility in check is truly unique and fills what we feel is a tremendous void in traditional managed account offerings.

Obviously the exact nature of what we do is proprietary; however the basic premise is based on the concept of relativity. HAMI monitors a very large universe of tradable commodities for opportunities, yet, is highly selective in those trades that it will take. For approximately every 5 trading opportunities identified by HAMI’s combination of over 10 trading systems, only 1 will be taken. Our algorithms are not only considering the markets direction and movement potential but just as importantly, how that potential ranks on a risk adjusted basis. The idea is that an opportunity can only be evaluated relative to what else is available. For example, how would you know if earning 5% was good or bad? The answer should be “it depends on what else is available”. In other words, the 5% return is only good or bad relative to other options. What HAMI Inc’s. strategy attempts to do is identify a limited percentile of all the markets it tracks as being the best candidates. Then, only those markets will be considered should one of our many systems generate a signal.

The portfolio selection process is dynamic and rebalanced every day. This means that from day to day the basket of markets that we will consider trading changes. We feel this keeps our trades limited to only those markets with the best risk adjusted potential. This allows us to evaluate a very large portfolio while still keeping the number of trades and margin requirements very low.

Monitoring a very large portfolio is critically important because if you initially limit yourself to a predetermined small portfolio, how do you know that those markets will be the best markets in the future? (Hindsight bias portfolio selection is a form of curve fitting and is a major downfall of many traders). If an exceptional opportunity develops in a market outside of your predetermined portfolio wouldn’t you want to take advantage of it? By trading with our strategies you don’t arbitrarily rule out any market that may perform well in the future and you have eliminated the tendency to pick a portfolio based merely on past performance (curve fit) considerations. The key is researched logic that can do this automatically and that’s what Hoffman Asset Management Inc. trading strategy utilizes.

*Hoffman Asset Management Inc. attempts to limit risk but no guarantees to limit losses to a certain percentage can be made.

PAST RESULTS ARE NOT NECESSARILY INDICATIVE OF FUTURE RESULTS.

Mr. Dean Hoffman attended Pennsylvania State University where he studied computer science. In 1987 Mr. Hoffman initially began his career as a commodity broker and worked for several large futures commission merchants in Chicago. After many years as a broker, Mr. Hoffman formed his own trading firm at the Chicago Mercantile Exchange. Throughout this period Mr. Hoffman intensively researched and developed algorithmic trading systems. In 2001 Mr. Hoffman formed a financial software firm, Strategic Trading Systems, that markets algorithmic trading systems.

This firm is a corporation that has been registered with the CFTC as a commodity trading advisor since February 2000, and Mr. Hoffman has been registered with the CFTC as its sole associated person since that date. In June 2004 Mr. Hoffman formed Hoffman Asset Management Inc. He became registered with the CFTC as an associated person of Hoffman Asset Management Inc. on August 4, 2004, and he became an NFA Associate on the same date. Mr. Hoffman is responsible for all trading decisions as well as the day-to-day operations of the Advisor.

Mr. Hoffman resides in Central Pennsylvania with his wife and three children.

Website: http://www.hoffmantrading.com

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