Notionally Funding a Trading Systems Or Managed Futures Account

7

When an investor looks at the performance of a trading system or Commodity Trading Advisor, one of the most significant statistics is what the required minimum account size is. It makes no sense considering trading systems or managed futures that have $100,000 minimums if the investor only has $50,000 to invest.

However, it is valuable to know that frequently the investor can start with less than the minimum through notional funding. For example, an investor could notionally fund a managed futures or trading systems account at the $50,000 level but tell the manager to trade at a nominal $100,000 level. In other words, the account will trade as though there were $100,000 in it even though there is not. The investor is simply making use of added leverage.

In the previous example this means that the account will be trading at 2-to-1 leverage. Meaning the investors will have gains and losses at twice the level. Had the investor only put up a third of the nominal amount minimum then he would see gains and losses at 3 times the level and so on.

Why those using Trading Systems or Managed Futures Might Want to Consider Notional Funding

Notional funding can be an efficient use of capital, because frequently a trading system or managed futures account will not come anywhere close to using all the money in the account. For example, in Hoffman Asset Management’s case we have a margin-to-equity ratio of generally less than 10%. What this means is that for every $100,000 invested, generally speaking, we will be using less than $10,000 at any given time for margin. The remaining $90,000 sits on the sidelines stagnant. Although it is true that interest on those unused funds can be earned, most investor’s feel they could do better investing those funds elsewhere. Often time’s high net worth individuals or institutions will even put NOTHING in their accounts and trade 100% notionally. The question for investors should be “how can I calculate a reasonable notional level to invest at”.

We feel the answer to that question is one that can be computed based on several statistics. Specifically, what is the maximum drawdown expected and what is the maximum margin that might be needed. For example, Hoffman Asset Management (as of this writing) has had a maximum drawdown of about 17% on a $125,000 nominal account size. This means a $21,250 drawdown in cash terms. The maximum margin usage is about 15% on $125,000 or, about $18,750 in cash terms.

To compute a notional investment amount, we suggest that an investor add the maximum expected drawdown and the maximum expected margin usage. This figure would give the investor the absolute minimum they could invest in the account without having a margin call.

In the previous example, if an investor had started on the worst possible day, and had a $21,250 drawdown, and simultaneously had the maximum margin usage of $18,750, he would have needed a $40,000 of cash in the account to fund that $125,000 nominal account size. Once again, some institutions and individuals who are not worried about margin calls may even decide to fund the account with less than that (or zero).

Benefits to the Trading Systems or Managed Futures Investor

This allows for the smaller, but more aggressive investor to participate in the program without needing to tie up the entire amount in cash. This will amplify their gains and losses at the added leverage level they are using. If, for example, the manager made a 30% return with a 17% drawdown, then the investor at 2-to-1 leverage would have experienced 60% gains with a 34% drawdown.

Once again, this is a more aggressive approach, and we recommend this only for investors who fully understand the benefits and risks of notional funding. However, for the right investor, this can be a valuable tool to have in his or her arsenal.



Source by Dean S Hoffman

Leave A Reply

This website uses cookies to improve your experience. We'll assume you're ok with this, but you can opt-out if you wish. Accept Read More

Privacy & Cookies Policy