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Adjusting Futures Returns for Margin


#1

I have just seen so many people come on here use huge amounts of leverage and then have their account blow up. To judge if the returns from a trader are due to skill or margin, I have started trying to judge them as if I was trading their strategy with no margin or leverage.

So, take a real example of a strategy that only trades Dow mini contracts and only trades one at a time. The first trade occurred on November 27, buying one contract for $23,543. If I was going to trade this strategy using no leverage it would require that I have an account with $23,543 * 5 = $117,715. As of today that strategy equity curve on C2 has grown from $7,500 to $14,536, a gain of $7,036. Now with the way C2 calculates it that is a cumulative gain of 94%! However, my method of adjusting for margin would say that the $7,036 as a percent of $117,715 results in a cumulative gain of about 6%. Over that same time period the Dow did about 5.1% based on closing data (not sure on a minute to minute comparison).

  1. Do you think it is fair to do this strategies to compare them and test the skills of the trader?
  2. Do you do anything similar?
  3. In this case would you attribute the 94% return to margin or skill?

A Strategy for YM
#2

Trading is pretty much gambling unless you trade with a statistical advantage such as having a profit target of 3 to 5 times the stops. For example, to have a 5 to 1 profit target to loss ratio wil require only a 20% win/loss ratio to breakeven.

This is how to use statistics to improve the odds of success.

No matter what people think trading involves risk and is as such gambling but we can always improve our odds.


#3

I am not sure I understand your point. If you go to a casino every day and stick to losing $100 max per day and stopping for the day after you make $300 you will still end up broke. Setting profit targets and stop losses alone don’t give you a statistical advantage.

The best profit targets and stops can do is is provide good money management and prevent you from blowing up a strategy with a statistical advantage. Going all in on a 99% favorable probability game can still make you broke. So this is where max risk per trade come in, but again profit targets and stops are not the statistical advantage.


#4

@Armenelos, sorry I didn’t explain more clearly but yes its money management is what is required to turn an average system into a losing system. Hard targets and stops are what provides the money management.

I am not saying that you only have a target and stop but you must set a defined target and defined stop which is risk control. So in my example if you have a system that trades with a hard stop rule of 5 times stop loss for example then all you need is a 20% win/loss ratio to breakeven. If you have a higher win/loss ratio you will come out ahead.

Hope this explains it better.


#5

@Armenelos, also with any trading system the win/loss ratio is hard to gauge over a short term. If that win/loss ratio can be achieved over a 5 year span then that would be a better gauge. But as you are also aware the markets change constantly so what may work 10 years ago may not work in todays markets.


#6

Risk management is fundamental as part of the success or failure of a strategy. From my point of view, it is very important to determine if a strategy faces greater vulnerability to systemic risks or to the risks inherent to the portfolio. There are several risk management mechanisms. Some work better against systemic risks and others are more effective against non-systemic risks.


#7

@AlgoSystems and @GonzaloLoayza2 I totally agree that risk management is important. I am more so curious what people think about comparing a strategy in this way. I mean to me if you look at the strategy above adjusted for margin it only outperformed the market by 1%. I think I would be more impressed by a strategy that only bought and sold the Dow and outperformed by 2% without leverage. Of course on C2 that strategy wouldn’t look nearly as good. Do you guys take margin into account when screening for new strategies to follow? If so how?


#8

One of the reasons to trade futures is leverage. If you exclude it, then I am more than sure that in average it will be the same as stock trading. I would adjust % of returns and drawdowns for your capital and compare it with other adjusted strategies.

For example trading only 1 contract:
Trader 1 started with 10k, get to 20k —> 100% return
Trader 2 started with 50k, get to 60k —> 20% return

Returns are the same in $s with the same scaling, but 1st trader will have more subs on c2 due to better percents. :slight_smile:


#9

Exactly, that’s how some developers in here without TOS manipulates their return n investors who have no clue about Futures, commodities, options, jump in with limited capital or over scale. Be careful when you subscribe a developer who use paper trades and short period times ( less than 6 months) with impressive return. They just want collect subscribers’ money without thinking risk management, etc.


#10

I have specialized in investments in stocks and ETFs. I never leverage my account. I have developed some strategies that use ETFs x2 or x3. These are the only cases in which I use this mechanism. Greetings.


#11

To me that just seems so much safer. Basically makes it so even in a catastrophic overnight 75% drop the max you could lose is 100% correct? Basically your ETFs and ETNs can go to zero but if you didn’t use margin you can’t owe money.


#12

In my case, that is not possible. My risk management includes a series of mechanisms and tools that avoid this alternative.


#13

Do you mean you hold hedging options?


#14

The options work quite well when your portfolio has a high r2 (r squared). Since my portfolios are 100% quantitative, the first thing I do is get the r2.
If r2 is high (80% for example), then I focus on the mechanisms and tools designed to control systemic risk.
If the r2 is low (20% for example), I concentrate on the mechanisms and tools designed to control the non-systemic risk.
I believe that this process is very important in the design of risk management. An error in this process can generate very serious problems in the portfolio.


#15

Adjusting futures returns for margin as a way of comparing strategies is a pointless exercise because it completely misses the most important point, which is how much gain you’re getting per unit of risk. You have to standardize the returns to the risk/volatility. Standardizing is the only way to compare performance.

This can be expressed in many variations, e.g. average annual return/average annual drawdown, Sortino ratio, Tail ratio, Information ratio, etc. Pick whichever you like best.

The size of the returns on its own isn’t useful performance information. To use the OP’s original question…his example trade leader may have made a smaller return than the S&P over the same period but if his Sharpe ratio outperformed the S&P then his strategy is still a better investment.

Once you’ve internalized that it’s all about how much return bang you get for your risk buck, and you’ve found some strategies you like, then you do a sense check to make sure the strategy isn’t taking hidden tail risk (cough selling naked options cough).


Futures WealthBuilder goes private
#16

Really? You said it is all about “how much gain you’re getting per unit risk.” The more margin you use the more you are increasing your risk. In my opinion it is doing exactly what you suggest just in a different way than sharpe etc. I agree analyzing the returns on it own isn’t useful, which is why I agree that adjusting them for margin/risk is not pointless. All the ratios especially on C2 only take into account what has already happened. If you have had nice tranquil trading with no stops and huge leverage you have an excellent Sharpe etc. such as many of the strategies we have seen blow up using futures. I totally agree that the selling naked options is risky but if that is then why isn’t holding and doesn’t pass the “sense” check. I just don’t understand why having 10-20 times your account balance at risk is any different.


#17

Troy,

Those are two separate conversations.

Gain per unit risk = standardized performance.

Margin and leverage = position sizing and risk management.

The former is what you use to tell you how good a strategy is. The latter domain is where you figure out, given the former, how hard you can push on the figurative gas pedal.* You can have a money-printing futures strategy, say 90% winners and 2:1 win/loss ratio, but if you overleverage it WILL blow you up. Just a matter of time.

The OP is talking about leverage as it relates to performance. To me, leverage and scaling is not a conversation that comes out of talking about strategy performance. Leverage belongs in the world of sizing, scaling, risk management, etc.

*There is a big big caveat here too which is that we’re implicitly assuming that we can rely on past performance to continue into the future. It won’t. That’s why I recommended doing a sense-check or stress test of the risk side of the equation for each strategy you have. A naked short options strategy with a Sortino of 3 does not have at all the same risk profile as a day trading strategy that uses fixed stops and also has a Sortino of 3.


#18

in my opinion that c2 need adjust how annual return (compounded) is shown. if there strategy has less than 12 month history, just show the current gain YTD. because a new strategy will try to swing for the fences first 3 month, c2 end up taking that gain and x4. so a strategy with 50% gain in 3 month now show on front page as 200% gain. that is just misleading. or take 1 month return x 12.

from here c2 takes expected 200% performance into calculation of c2 score. that why you see SO MANY new strategies on top 20 list.

in regarding futures, i think if the strategy trades futures. the subscriber needs to enter MAX contract will be traded as a requirement. NOT allowing the leader to trade endless contract and martingale endlessly for 10 days straight or until it blows up!

just my 2 cents.