CTA Trading Strategies

CTA Trading Strategies: Backtest Analysis and Financial Advisor Insights

A commodity trading advisor (CTA) is an individual or organization that provides personalized advice and services related to trading in futures contracts, commodity options, and retail off-exchange forex contracts or swaps. It could also be a fund that uses a managed futures strategy, investing in futures and options contracts.

The commodity market is highly specialized and requires specialists in the game for investment advisory and management. This is where CTAs come in, but who are they?

Let’s take a look at CTAs and what they do. At the end of the article, we provide you with a backtested CTA trading strategy.

What is CTA in trading?

Commodity Trading Advisor (CTA)

A commodity trading advisor (CTA) is an individual or organization that provides personalized advice and services related to trading in futures contracts, commodity options, and retail off-exchange forex contracts or swaps.

Financial advisors are responsible for trading within managed futures accounts. Investments placed with a CTA are referred to as Managed Futures because the CTA can manage each client’s individual account, placing trades in the client’s account directly on their behalf, similar to a personal investment manager.

A financial advisor can also run a CTA fund, which is a hedge fund that uses a managed futures strategy, investing in futures and options contracts. The true value of the investment programs offered by CTAs is their portfolio construction approach, which allows investors to simultaneously participate in multiple global market sectors such as foreign exchange, energies, metals, interest rates, equity indices, and commodities.

In essence, CTAs are professional investment managers, similar to portfolio managers in mutual funds, who seek to profit from movements in the global financial, commodity, and currency markets by investing in exchange-traded futures and options and OTC forward contracts.

CTAs are usually compensated through management fees calculated as an annual percentage of equity in the fund and incentive fees calculated as a percentage of new trading profits. No incentive fees are charged if the CTA does not generate a profit exceeding a hurdle rate or high-water mark.

Advisors who provide such services are required to be registered as a CTA with the Commodity Futures and Trading Commission (CFTC), as well as become members of the National Futures Association (NFA), the self-regulatory organization for the derivatives industry.

What is systematic CTA?

While a few CTAs use discretionary strategies, many of them use a systematic approach, which makes trades based on models coded into trading algorithms. The signals of the trading models could be based on technical analysis using charts, trend following, and momentum indicators, as well as from fundamental factors — economic data like energy supply and demand, employment data, and so on.

A true systematic CTA will rely solely on the buy and sell signals generated by their trading algos and won’t intervene at all. So, the effects of human emotions are drastically reduced.

CTA strategies are a big business

The CTA business – which is mainly trend followers – is a big business. CTAs manage $350bn in funds and managed accounts, and there is probably half that again in in-house implementations, multi-strategy funds etc.

What is CTA trend following?

Whether a CTA is systematic or discretionary, their trading strategy can be based on trend following. In fact, trend following is used by commodity trading advisors (CTAs) as the predominant strategy.

The best strategies can be found in our….

Strategy Shop

Backtested trading strategies

If you want to read more about trend following we have listed a few very relevant articles below:

The objective of trend-following CTAs is to identify medium to long-term trends in a systematic way. The implementation of a trend-following strategy on an instrument level includes two key elements: signal generation and sizing of exposure.

An example of a systematic trend following fund is the Swedish money manager Lynx. They have a good track record dating back to the year 2000 with a CAGR of about 10% per year. But the best part of it is that the returns are mostly uncorrelated with the returns from the stock market.

CTA momentum strategy

Many CTAs use momentum strategies, which they implement with a multi-asset universe, involving equity, bond, currency, and commodity futures contracts. CTAs often trade multiple asset classes with conflicting momentum. An obvious example is equity and bond futures. During prolonged periods of market stress, bond momentum tends to be positive while equity momentum tends to be negative.

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CTA hedge fund strategy

CTAs can run a CTA fund, which is a hedge fund that uses a managed futures strategy, investing in futures and options contracts. Most CTA funds invest based on systematic strategies, but there are fund managers who actively manage investments using discretionary strategies.

CTA vs hedge fund

The key difference between CTAs and hedge funds is that CTAs are limited to trading futures, options, and currency swaps contracts, whereas hedge funds can trade a greater range of securities, including equities, bonds, and derivatives.

Also, some CTAs operate just as advisors or manage individual commodity trading accounts. However, most CTAs are now structured as a Managed Futures Strategy incorporated as a hedge fund but trading only derivative contracts (futures, options, and swaps).

CTA trading strategy (backtest and example)

There is no typical CTA trading strategy. However, in order to make and implement a strategy you need to do the following:

  • To have a trading idea. There are ways to get trading ideas.
  • Once you have an idea, you need to make a backtest of the trading idea. (What is backtesting?)
  • When the backtest is done, you must select a trading universe for the strategy (if the strategy is validated).
  • If the trading strategy will be used on different asset classes, you must find the right weightings for each asset.
  • When the weightings are done, you have to look at the risk management.
  • Perhaps the most important risk metric is correlation to the other trading strategies (more about this later).
  • Last, you must incubate or paper trade the strategy for a few months. If it goes well, then execute it and trade it.

We have previously made a couple of profitable trading strategies that could potentially be a CTA strategy. Most CTA trading strategies can be labeled trend following. These can be systematic, meaning what we do on this website (quantified strategies), or discretionary. The latter means they are executed by the fund manager while the former most likely are executed automatically by a computer.

Let’s go on to look at a simple (and perhaps naive) strategy, buy yet pretty effective. We start by using the 200-day moving average trading strategy: we are long S&P 500 when the close is above the 200-day moving average, and we are out of the market when it’s below. This is what the equity curve looks like for this simple backtest:

CTA trading strategy
CTA trading strategy – the 200-day moving average.

The logarithmic (linear vs logarithmic scale) equity curve above has a max drawdown of 28%, reached in 2002, and the CAGR is 6.73% while buy & hold is 7.16% (the test is not adjusted for dividends). S&P 500 trends little in the short term, but in the long term, the trend is up. Thus, such a simple system catches most of the gains in the stock market while limiting the losses along the way.

A professional CTA trader or investor will most likely not use such a naive system or strategy. However, we believe this is a starting point to make a CTA trading strategy.

Trading is all about making it easy and having strategies that complement each other. Complexity is not going to make you successful – quite the contrary. We have covered this in earlier articles:

CTA trading strategy – correlation

The most important thing for any CTA is to have many uncorrelated CTA strategies that complement each other. This is such a simple yet extremely important issue. The chart below shows the importance of this:

CTA trading strategy - correlation backtest
Brummer & Partner’s return. Source: Website.

The chart above contains the return of Brummer & Partners’ Multi-strategy fund. The grey line is the total return of the MSCI World Market.

Which return would you rather have – the red line or the grey line? Many would pick the grey line because of the higher return, but we are confident almost all CTAs would rather have the red line. The reason is simple: less swings and volatility in the capital.

How did Brummer & Partner manage such steady returns?

That is because the fund invests in multiple hedge funds that run different types of trading strategies. They don’t add funds based on performance, but rather on correlation to the existing funds. Even a “mediocre” fund can add a lot of value if the correlation is low to the other strategies or funds.

Thus, when you make backtests, you need to look at correlation just as much as performance.

List of trading strategies

Since we started this blog in 2012 we have written many trading strategies that you can read for free, please see our trading strategy examples. The strategies can help you copy some of the ideas and logic that CTA traders use.

We have compiled the Amibroker code and logic in plain English for all these strategies (plain English is for backtesting in Python). If you subscribe, you’ll get the code for the latter strategy (plus over 150 other ideas).

For a list of the strategies we have made please click on the green banner:

These strategies must not be misunderstood for the premium strategies that we charge a fee for:

FAQ (frequently asked questions) CTA trading strategy

Let’s end the article with a few typical frequently asked questions about a CTA trading strategy:

Q. What is a CTA trading strategy?

CTA (Commodity Trading Advisor) trading strategies are a type of investment strategy that uses quantitative analysis and automated trading systems to identify and capitalize on market opportunities.

CTAs typically employ a variety of quantitative models to help determine which trades to make, and when to make them. CTAs also typically employ risk management strategies to help reduce potential losses.

Please see our example further up in the article.

Q: What is the benefit of using a CTA trading strategy?

Using a CTA trading strategy can help to reduce the risk of losses and provide a more consistent, automated approach to trading. Additionally, some CTAs specialize in certain markets or strategies, which can help to capitalize on market opportunities.

The key here is correlation among a portfolio of trading strategies.

Q: What types of markets can be traded using a CTA trading strategy?

CTA trading strategies can be used to trade a variety of markets, including commodities, stocks, currencies, and futures.

One of the aims of a CTA is to trade different asset classes to have strategies that are not very correlated.

Q: What are the risks associated with CTA trading strategies?

As with any type of trading strategy, there are risks associated with CTA trading strategies. These include the risk of losses, the risk of market volatility, and the risk of inaccurate or unreliable data. It is important to understand these risks and to develop an appropriate risk management strategy prior to trading.

That said, used wisely, a CTA strategy can reduce risk if it’s uncorrelated to the other strategies.

Q: Are there any limitations to using a CTA trading strategy?

Yes, CTA trading strategies may have certain limitations, such as the need for a certain level of capital and the need for specific market knowledge. Additionally, some strategies may be more complex than others and may require more advanced trading knowledge.

However, complexity doesn’t necessarily add value, perhaps quite the opposite. Please read our take on simple vs complex trading strategies.

Q. What makes a good CTA strategy?

A good CTA is one that is able to produce good risk-adjusted returns. See the example above and the performance chart of Brummer.

Q. What is a systematic CTA?

It’s one who is, as the name implies, very systematic in his approach to trading. He or she uses models and trading algorithms.

Q. What is a trend following CTA?

A trend-following CTA is one that uses trend-following strategies.

CTA trading strategy – ending remarks

If you are a CTA you most likely are a “professional”. You understand the most important concepts of trading and investing, and you realize trading is no quick fix to getting rich. Thus, any CTA trading strategy is mostly about correlation – not necessarily about having the most profitable trading strategy.

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