CTA Trading Strategy — What Is It? (Backtest)

Last Updated on August 28, 2022 by Oddmund Groette

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?

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.

Let’s take a look at CTAs and what they do.

What is CTA in trading?

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.

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.

An 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.

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 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.

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.

A cross-section momentum is called a winners-minus-losers strategy, which assumes that the current winners will continue to outperform the current losers in the future. With this theory, they build a portfolio that is long on assets that have outperformed within their observation period (say 3 months or 6 months) and short on assets that have underperformed within the same observation period.

So, if they have an asset universe of 20 assets that are ranked according to their performance over the last 3 months, they may go long on the top 5 and go short on the bottom 5.

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)

A backtest of a cta trading strategy is coming soon.

Similar Posts