If you have clear understanding, then no matter what clouds others try to create, you will see what is right. PY
A Standard Deviation Story-
Traditional volatility measurements for managed futures originated from statistics. Using monthly past performance data we calculate an average or mean over a specified time frame. We then evaluate how monthly returns deviate from the average. Standard deviations in one form or another are applied to both negative and positive returns.
When attempting to statistically project future returns using past performance data, your analyst should be thorough enough to integrate probability analysis of future market conditions (scenarios) that might occur. A first-rate analyst should also attempt to project the quality of each market condition within each scenario.
For example, there are three basic market conditions: Up, down and sideways. Most markets enjoy sideways activity with a positive or negative bias 85% of the time. Since most of us are blindsided to a longer term bias we usually get stuck trading sideways markets without awareness of the bias, volatility or the quality of market movement within the sideways range. We get chopped up until we learn to adapt our trading discipline to current market conditions. Floor traders excel at “trading whatever the market gives,” or being flexible. Automated systems are totally opposite, they require that markets adapt to what they can define and act on, which is probably why performance of automated systems is usually so poor. At the very least, to me they seem to waste too much capital. If we quantify the quality of market activity within each major market condition we can design our composite strategy to accommodate most market conditions.
Performance averages and standard deviations can then be weighted relative to the probability of each scenario becoming material reality. If a standard deviation is high the investment is “believed to have more risk” than an investment with a lower standard deviation. Sub-accounts or markets within the investment can be reallocated until the data shows the greatest return potential with the lowest standard deviation.
This is a simple description of one widely used method of risk management. Pay attention to the conversation of people who have never traded yet analyze the work of other traders. The big question is: “What is YOUR portfolio’s standard deviation?”
Traditional texts from the New York University Professional Bookstore for MBA students on investment analysis and risk management devote several chapters on building multiple investment portfolios using standard deviation and correlation analysis as a risk management strategy. That strategy is not extended into managed futures investments. Specifically
- Modern Portfolio Theory and Investment Analysis – Elton/Gruber
- Essentials of Investments – Bodie/Kane/Marcus).
Most interesting is Gruber’s book and the admission of needing more knowledge for evaluating futures investments. They use traditional rate of return data of public commodity funds to lightly reference managed futures and why the investment should be avoided. Sadly, anyone using public fund performance as a benchmark for any research or teaching project will always succeed at proving that the investments are not profitable and should be avoided at all costs.
Also using any benchmark or index to “judge” the quality of any managed futures investment will always prove to detract from our objective, to build a profitable managed futures strategy. Read Article # 32 Benchmarks and SafeMoneyMetrics®
A Foundation Burdened With Error Will Only Multiply Error – Nothing Else is Possible
- Past performance data has no relevance to capital at risk relative to realized investment returns.
- Past performance returns are calculated using the advisors fully funded account size. Fully funded account sizes never have and never will have relevance to any direct risk/return evaluation.
- Past performance always includes open trade equity – open trade equity is volatile and when viewed in isolation has no relevance to evaluating investment risk at a direct level of cause.
- Past performance data does not consider under what market conditions the returns were earned. Nor does it understand that those conditions will never, ever repeat themselves.
- Volatility of returns measured by a standard deviation of traditional past return calculations relative to an average return for the same time frame has no relevance to the risk of your managed futures /options investment.
- Volatility measurements are easily manipulated by account size.
Volatility Works For Not Against You
Humor me: Pretend you opened a managed futures /options account for $250,000. After a complete due diligence and SafeMoneyMetrics® analysis - we decided to allocate capital as follows, because of conditions described.
- Capital was allocated at a 60%-40% split between two advisors.
- Composite maximum capital at risk is 20% of total account value. The average is 15%.
- Traditional rate of return averaged 33% annually for 36 months. Remember traditional ROR is calculated using the total account value. The actual capital at risk used to earn the 33% was 20% of total account value. Most important is to remember that traditional ROR calculations have only one purpose for us – to be used in conjunction with SafeMoneyMetrics®. Composite analysis offers insight into the advisors skill level and consciousness. Consciousness is the key to successful risk management under any circumstance. Later in this article, I’ll briefly introduce why and how. In-depth analysis of consciousness as a risk management strategy will be in later articles.
- The average annual realized ratio was 160% and the maximum was 195%. A realized ratio is realized trading returns earned on real capital at risk. The ratio expresses direct trading talent over a specified time frame.
- The volatility ratio measures fluctuations of open trade equity relative to capital at risk. Over specified time frames; it averaged – 6%, maximum +8, minimum – 33%. The composite portfolio never experienced more volatility than a 33% loss of capital at risk to earn the 33% average annual return on total account equity, or 195% realized return on maximum capital at risk which is only 20% of the total account value.
- The annual net SafeMoneyMetrics® ratio averaged 165%. Net Ratio is a combination of the realized and volatility ratios. Both ratios are based on capital at risk not total account value which with the right advisors is rarely at risk anyway.
NOW Pay close attention: Monthly returns were erratic relative to the average return for the 36 month time frame evaluated. Traditionally “erratic returns translate into a high standard deviation” and are perceived and interpreted as a HIGH RISK INVESTMENT THAT SHOULD BE AVOIDED AT ALL COSTS.
Let’s consider a different “perception” ………
So What and Who Cares
Assume that the advisor does a remarkable job of managing market risk. This is proven daily or even momentarily on live data by monitoring a very simple relationship between the realized and volatility ratio, nothing else matters. End of Story!
We can now claim that the legendary Standard Deviation – as traditionally applied to managed futures and options is superfluous human interference designed to increase risk, lower returns and deprive us of low risk, potentially lucrative investment opportunities.
All I did was bring your attention to a more direct application of “truth,” giving you more freedom and inner strength to make better decisions.
Maybe we should take time to evaluate our beliefs relative to the misery we cause ourselves. I say that because all misery is self-inflicted. Nobody can do anything to us without our permission and nothing ever happens to us that does not emanate from within our consciousness.
The entire industry is built upon the same standard deviation belief – the “belief” is also perpetuated using print and electronic media. So not only do we inflict misery on our selves – we circulate our “legacy” at lightning speed to anyone who will listen.
The bottom line is: An advisors ability to translate unrealized equity into realized trading profits at the lowest cost and risk is just about all anyone needs to know about any managed futures /options investment.
That ability is easily quantified and FREE by monitoring a relationship between two simple numbers, the realized and volatility ratio. That foundation and its ever – changing relationship is the most direct route to successful risk management that currently exists in our industry.
The chart below, used in an earlier article includes the Net ratio. Since the net closely tracks the realized, we can assume that the advisor has superior risk management skills. WHY? Because he/she can translate unrealized equity into realized, money you can spend!
Quantifying Consciousness = Superior Risk Management
Consciousness as we define it – is the “universal intelligence” that creates every aspect of material reality. The material world is created from consciousness that lives through people. Nothing material can escape this truth. Individual beliefs dictate degrees of consciousness or how “IT” functions. Similar to how a diamond reflects light –light is pure and direct, as light bounces off facets of the diamond the quality of that light changes. Consciousness in its purest form is LIFE ITSELF. The quality of consciousness expressing itself through each person is like light reflecting off different facets of the diamond.
When the spark of God is dormant, mankind’s basic nature is to survive at someone else’s expense (fear). The “beliefs” and living spark of our Creator driving each individual life dictate to what “degree” our lower (fear) nature is expressed. Nature is consistent in all people until our consciousness shifts from “getting” to “giving” – or we are “awakened” to our higher nature. That Universal Intelligence is the ONE Source of all life abundantly given to all people and It lives freely within each of us. Without it we are clothes hanging in a closet waiting to be put on so they have life.
The body is to clothes as Universal Life is to the body – there is no difference. Beliefs block the flow of life in its purest form. Imagine a TREE earning its life – or imagine it killing another tree so it survives. Impossible right! Well just like trees grow – we are supposed to be like that too – we lost our way – slowly one at a time we’re waking up – as we wake up – destruction will stop – people will become kinder – we became too destructive and no longer have any choice.
Anything created by mankind will eventually outlive its usefulness. So if we develop risk management strategies that incorporate quality of consciousness, and align our decisions with the eternal nature of Universal Intelligence we manage risk at the deepest and most thorough possible level known to mankind. Once consciousness is quantified all mathematical aspects of risk management can diligently be applied.
A few strategies for quantifying consciousness in managed futures are to be aware of the With Life strategies.
Application |
Against Life |
With Life |
Modern Portfolio Theory |
30 markets are traded because each market moves independently of the others yet 26 lose money |
30 markets are considered. Trading results may or may not be correlated to lower composite risk of the entire portfolio. |
Use of Indexes |
Performance evaluation is compared to an index to “Prove it’s Worthiness.” FACT a decent individual investment in managed futures will usually have better performance than an index. Any comparative relationship between one advisor and an index of advisors even in the same market sector are BOGUS. |
Can possibly show how traders within market sectors are performing relative to current market conditions. Possibly as a timing vehicle for entering or leveraging investments. (DB Stark and Co. has a direct approach to using indexes that seems to make sense). |
Use of Traditional Past Performance Data |
What we do is better than nothing and much better than what we used to do –beyond that one high point most everything we currently offer needs work! |
Prudently integrated into thorough methods of risk management, the data offers insight into alpha or beta returns. (Talent relative to market conditions). |
Actual Cash Relative to Notional Account Size |
The difference between actual funding and notional account value is wide – and the actual cash related to capital at risk is narrow. |
The capital at risk relative to actual cash is wide – and the actual cash relative to notional can be wide or narrow has no relevance. WHY? Although we may have to compensate advisors on the fully funded account value – we only fund an account at the actual cash value. We prefer advisors with lower funding values and good ratios. If we invest the difference between actual and fully funded in a risk free investment, fix management fee costs are reduced. |
Margin for Trading Relative to Fully Funded Account Size |
Same as Above |
Same as Above |
Focus on Annual Returns |
Only past annual returns from January to December are presented |
Annual returns and time windows are presented |
Using the Investment |
In isolation without consideration of your entire strategy |
As an impeccable risk management strategy in concert with your entire portfolio |
SafeMoneyMetrics® raises a standard for all people. Its’ basic nature seeks the simplest truth at the lowest cost and risk not only for traders, but for sponsors and investors. Everyone always benefits when higher levels of consciousness are applied to creating material reality. It’s physically impossible for anything else to happen.