"Let truth be what it is. Do not intrude upon it, do not attack it, do not interrupt its coming. Let it encompass every situation and bring you peace. Not even faith is asked of you, for truth asks nothing. Let it enter and it will call forth and secure for you the faith you need for peace. But rise you not against it, for against your opposition it cannot come. " Course in Miracles Text Pg 345
What is RTR/CAR and the 51% Rule?
RTR stands for Realized Trading Returns and CAR Capital at Risk. It is one relationship used in SafeMoneyMetrics®. As 2nd generation in futures, the 51% rule is a family legacy. "I only have to be right 51% of the time," were my Father's words. Since we made money just about every year for over 30 and the rule was adaptable for today's marketplace, we decided to perpetuate what works! See Article # 16 Refining Performance Evaluation.
When evaluating a single trade within a stand-alone environment, hedge or investment strategy, bottom line considerations are capital at risk, cost of money and time relative to potential return, nothing else matters. We created a ratio called RTR/CAR. If the RTR/CAR ratio and the 51% rule remain undisturbed, is well. We will prove that statement shortly and throughout this article. The process is simple and keeps anyone (even me) focused on bottom line issues that support an entire strategy.
Variable parameters can be applied to consistent principles, so rather than being a rigid strategy that reflects values built on fear, it's also flexible creative and fun!
WHY Hedging?
My background is cash market and hedging. I am biased in views and probably too opinionated. Futures and options on futures were created for hedging related cash market risk. There are also numerous alternatives to futures and options, such as cash forward markets and contracting.
When people blindly say, "it's been proven that money belongs in futures, especially using my strategy" I perceive a self-serving motive, rather than a motive of service by managing risk. WHY? The asset management side of the managed futures industry is fraught with inaccuracies based on erroneous thought. Supporting documentation for this statement can be found in Articles - #14, 15 and 16. The futures industry evolved because of a need to manage risk inherent in the underlying cash market. Sometimes it spears that many managed accounts seem much better at annihilating money rather than managing risk. Since the process of choosing good advisors and successfully managing risk is easily rectified we did something about it.
How People Lose Their Way:
While researching "A Unified Foundation for Investment Selection" I was constructively influenced by the work of Professor David Bohm. His insights into how people learn, plus the devastating effects of fear on our physical health and quality of decisions were especially enlightening. Issues I have always metaphysically seen and known, physically felt, yet never had the language to express or mathematical means to quantify until now. For Example:
Modern Portfolio Theory (MPT), a Nobel Prize strategy for managing portfolio risk has been successfully applied to traditional asset management since the 50's. MPT has been adapted by professionals trading managed futures. Successful modification of MPT applied to managed futures would require supporting documentation proving that investment returns, among two or more strategies reduce volatility and risk. Yet many diversified traders apply the reasoning of MPT as justification for trading 28-35 markets.
FACT: Validation for trading 28-35 markets has no direct relationship to truthful application of MPT. Yet we allow ourselves to believe otherwise. Diversified traders may not only require larger account sizes to trade 28-35 markets but also to maintain low draw-downs. WHY? If margin requirements and trading positions are low relative to the account size; that translates into lower volatility of monthly returns. There is probably a consciousness of fear driving the strategy. Fear weakens decisions and increases risk. This can be analyzed using RTR/CAR ratio analysis and the 51% rule.
When not careful, we can easily find ourselves compensating below average traders larger fees to lose money in more markets on larger account sizes and call ourselves intelligent? WHY? Because traditional analysts making all the rules say we should! Truth will always set you free!
Financial professionals catering to personal and investor fears of large draw-downs have also caused a proliferation of unwarranted larger account size requirements. Partial funding is usually accepted, however advisors insist on being compensation on full account value. Larger account sizes reduce the "illusion" of losses to an account giving the appearance of stabilizing the track record. Question: Who actually evaluates capital at risk relative to return for the composite strategy and each market within the strategy?
How Returns are Calculated Traditionally:
Investment returns can be accurately analyzed by using a capital at risk relative to realized trading return strategy, nothing else matters. Account size, unrealized trading returns and interest earnings are three factors partially used to calculate traditional investment returns. They have NO relationship to capital at risk used to achieve a specific realized trading result, yet realized results are all that matters.
All secondary analysis is also built using traditionally calculated rate of returns, which have nothing to do with truth. So not only is the primary foundation for this industry built on seaweed, but secondary tools used for analysis include and perpetuate the primary error.
Millions of investors will continue to make poor decisions based on incorrect information, causing unforeseen risk unless something is done to turn the energy around.
Correcting the cause of loss requires looking at truth. Truth and common sense are lost in the process of building layers of error. WHY? Without thinking independently, people learn and adapt from their environment.
As Phil McGraw, author of Life Strategies would say "You need to start thinking and acting for yourself to stop your own misery. No one will do it for you."
How and Why Does the RTR/CAR Ratio Work ?
Basis is the difference between local cash market conditions and the nearest futures price. Basis remains constant no matter what market conditions are because basis includes analysis of the cash market. "Basis Analysis" is what people study and use when planning a buying or marketing strategy for their cash commodities. The nearest futures price is used to estimate the current cash market. Basically hedgers look at only two aspects of futures to formulate decisions. Basis and futures price, life is that simple folks!
We adapted the strategy to use for evaluating managed accounts. Our capital at risk formula replaces cash market price and realized trading return replaces the nearest futures price. Those two factors are always in a relationship that either adds to or detracts from account profitability. It is a direct consistent relationship that can be adapted to individual trade analysis, any time interval bulking trades, each market within the composite or multi-advisor strategies and composite results. It tracks error efficiently and will accurately perceive imbalances before month end rate or return during a draw-down and within the market or sector causing the weakness.
We also adapted the analysis to incorporate a ratio of realized returns relative to realized and unrealized for the same time frame. Although imperfect, it works for directly evaluating what any managed futures investment really is, the result of a human being taking disciplined action in a current market for the purpose of achieving a positive result.
Multiple Investment Comparison and Evaluation:
Most advisors use a percentage of a specific account size as allocated capital at risk for each trade. This does not guarantee that losses will not exceed that allocation, only that it does exist as part of their money management strategy. Since we have almost never seen that percentage exceed the margin requirement for each market, we decided that a working formula for capital at risk could include the margin requirement on each trade. Although imperfect, it is more truthful than evaluating advisors via an account size they decided they want. It is also consistent and can flawlessly be applied across a spectrum of advisors for evaluating and building multiple advisor portfolios.
Realized trading returns have no volatility and we can spend the money. The volatility of unrealized trading returns relative to what is finally realized would astound most mortals unfamiliar with derivatives. To quote my Father again "I only want my piece from the middle 51% of the time consistently." The RTR/CAR ratio relative to the realized and unrealized return for the same time frame can provide valuable insight into the strategies effectiveness over time relative to current reality.
Finally required account size has no real value in evaluating capital at risk relative to return except:
If we look at maximum margin an advisor uses relative to the account size they want, relative to the funding level they accept, relative to fees charged and volatility of the RTR/CAR ratio and realized and unrealized returns, we have insight into the strategy we are dealing with, without too much effort.
David Bohm - Unfolding Meaning