When we last looked at currency-specific commodity trading advisors, we saw an explosion of new programs that were targeting short-term strategies. Numerous advisors noted that there had been a fundamental shift in the markets that produced an environment that was better suited for short-term strategies.
If anything, that has continued though the sector has underperformed of late. The long-term bear market for the dollar has stalled and while many traders believe the dollar is due for a trend reversal, they are doubtful that will be a boon for long-term trend followers. They noted increased volatility and the fact that many of the long-term strategies struggled despite a sustained bear move in the dollar. “For some reason long-term guys did not take advantage of the large move in the dollar,” says Marek Chelkowski, a CTA who uses a mix of technicals and fundamentals in his short-term strategy.
“The market has been short-term oriented,” Chelkowski says. “Part of it is the participation of retail. We have become an instant gratification world.”
Joe Gelet, principal of Elite E services, says short-term intelligent algorithmic systems are the trend of the future in forex trading. “Long-term trend followers are going to have a lot of trouble because of the volatility. There are going to be more ‘black swan’ events like the subprime crisis and 9/11,” Gelet says.
The expectation of immediate profit is something Chelkowski sees beyond forex trading. “The Dow just rallied 450 points in two days and then reversed 200 points (in late July),” after doing the same thing two weeks prior.
Chelkowski is not complaining. “It is a good trading market. That doesn’t mean all short-term traders will succeed, just that there is the volatility that can allow short-term profits and being in the market for a shorter period can reduce your risk. Many of the moves will be quite violent,” Chelkowski says, adding, “The market is behaving jittery.”
Others traders are seeing it too. Mark Coe, president of Coe Capital Advisors, says “I am trading shorter-term. We are seeing a lot of whipsaws.”
Coe runs medium to long-term trend following programs with a carry overlay and has noticed that his trades are getting shorter because of the volatility. For example, he pointed out that when two news items came out of Europe on July 31, one pushed the Euro higher and the other caused it to tank (see “You’re in and you’re stopped out”). He says moves like this are becoming more common. “Even short- term traders may have been caught with that volatility,” Coe adds.
Tom Trimmer, third-party marketer and co-founder of Trimmer Capital Management, says the short-term managers have been performing better. Trimmer, who raises capital for 12 currency programs and analyzes many more, says, “It seems that the short- term guys seem to be cleaning up.”
Emmanuel Acar, CEO of Directional Trading Ltd, attributes this to survivorship bias. “There were short-term programs in the 1990s but many did not survive. Time will tell if the newer versions fade away or are answers to today’s markets,” Acar says.
While there is an element of survivorship bias, a perusal of the Barclay database shows that managers identifying themselves as short-term traders are outperforming the overall universe of forex-specific managers. Technical short-term currency programs have returned 8.77% in the last year and have a compound annual return of 14% as opposed to 5.45% and 12.61% for the entire universe of technical currency programs. Fundamental short-term currency programs have returned 16.42% over the last 12 months with a CAR of 25.29% as opposed to 5.29% and a CAR of 13.56% for the universe of fundamental currency programs.
They also appear to be in greater demand. “There is a huge interest in short-term traders,” says Sol Waksman president of Barclay Hedge. “There is a tremendous advantage to adding short-term traders to a portfolio because they tend to be less correlated as a group than long-term traders.”
That has been backed up by a study by Newedge. The paper, “Correlations and holding periods,” states, “Our ongoing conversations with managers and investors have produced a mountain of anecdotal evidence that short-term traders’ returns should exhibit low correlations — not only with the returns of nearly any other investment alternative but with one another’s returns.”
So basically you have to choose which long-term trader is best for your portfolio, but you can include several short-term traders without your portfolio becoming less diversified.
“There is a lot of money looking for good currency managers, so it makes sense to be in that space,” Trimmer says.
While the Newedge study is the basis for its Short-Term Traders Index (STTI) and deals with diversified short-term traders, its finding is particularly relevant for the forex sector. Because forex is the largest market sector and makes up a large portion of the allocations of many long-term trend followers, there has always been a strong correlation between currency programs and the overall CTA universe. Of the 144 currency specific programs listed in the Barclay database, 70 are listed as using short-term strategies. Of the forex-specific programs with less than a four-year track record, 59.67% list themselves as short-term traders; of the managers with more than a four-year track record only 40.24% list themselves as short-term traders (see “Gaining separation”).
The Barclay Currency Traders Index has produced a CAR of 0.66% since January 2005. That is much less than the CAR for the Barclay CTA Index, 6.56%, in that same time period and much lower than the overall CAR of the currency index of 8.16% since 1987.
And many managers are falling by the wayside. “We added five new currency programs in the last update [June] and deleted 10,” Waksman says. “It was the second month in a row that we deleted more currency programs than we added. It is the poorest performing of all the CTA indexes. It has been a difficult time.”
While there seems to be more currency specific programs, many of them have struggled in recent years. The number of currency specific programs in the Barclay database has dropped since we looked at the sector in February. The total number of 144 through June of 2008 is less than the total of 158 through 2007 (see “Manager atrophy”). Interestingly, a lot of the deletions are of programs that had a substantial track record dating back four years or more.
If long-term traders struggled with volatility during a pretty consistent bearish dollar trend, what will happen if the dollar continues to scuffle around ?
Gelet points out that for 50 years the dollar has been the reserve currency of the world and there seems to be no plan B. “Right now the dollar’s position as reserve currency is being questioned, but there is no alternative. The void is creating volatility,” Gelet says. He does not see the Euro stepping in because of the problems in Europe.
If we stay in a period where the dollar struggles but other currencies are not strong enough or the central banks of the countries will not allow the currency to appreciate further against the dollar, we could be stuck in a range.
“Because of the weakening economy and large deficit, the world does not have the dollar to lean on. There will be more problems before solutions,” Gelet says. That all adds up to greater volatility and fewer long-term trends.
Because of this he says intelligent trading systems that can act quickly will be the most successful. He believes short-term momentum models that can take quick profits and have good risk management will do best. “Long term it is getting too difficult to forecast.”
Coe says there are two sides to it and favors a dollar recovery. “The dollar has had every chance to fall off the cliff but it hasn’t. You have to ask what is the better option. We are in the process of a dollar bottom. My models have moved long the dollar. It is a battle over the worst currency, where are you going to run to,” Coe says. “I think the dollar will strengthen in the next 12 to 24 months.”
WHY IS IT SO HARD
The Newedge study asks the question, “If short-term has such desirable properties for portfolio management, why have more traders not been attracted to the space?” (The Newedge methodology pulls out sector specific managers.)
For one, the factors that have allowed even the contemplation of creating extremely short-term strategies as the basis for managing money are relatively new. These strategies used to be the exclusive purview of institutions and large proprietary traders, but the affordability of complex trading technology coupled with the reduction in brokerage costs have allowed these techniques to be used by emerging managers. This is particularly true in the forex arena where the barriers to entry are lower.
Forex managers can offer programs with lower minimums because they do not have to trade a minimum number of contracts for each customer. They can offer the benefits of managed accounts with the lower minimum investment levels of a fund.
Another reason there aren’t more short-term strategies is simply the degree of difficulty. To be truly non correlated with long-term trend followers, short-term traders must not only be short-term but also something other than trend following. Most long-term trend followers will tell you that their systems are based on simple technical indicators and where they earn their keep is with risk management. Long-term trends are easy to find whereas countertrend and momentum plays are more difficult.
Revolution Capital Management (see Trader Profile) set out to create a diversified strategy utilizing multiple time frames. They launched their long-term trend following program — which has been quite successful — in short order but took an additional two years to perfect their short-term approach. Revolution founder Michael Mundt says it was “simply harder” to do and took the help of an established manager’s operation to perfect.
It is difficult to predict what types of programs will outperform in the future, but it is clear that there is a greater demand for short-term programs and the factors that allow those programs to exist and thrive are relatively new so we are just seeing the beginning of what they can do.