CTA Strategies

Commodity Trading Advisors (CTAs) have been a prominent force in the financial markets since the 1970s. 

These specialized traders focus on trading futures contracts and other derivative instruments across a wide range of asset classes. 

Their strategies, known as managed futures, offer a unique approach to diversification and potential returns.

Key Takeaways – CTA (Commodity Trader Advisors) Managed Futures Strategies

• Diverse Market Exposure

• • CTAs trade across multiple asset classes, including commodities, currencies, interest rates, and stock indices (both long, short, and in between). 
  • This broad diversification helps smooth returns and manage risk.

• Trend-Following Focus

• • Most CTAs use systematic, algorithm-driven strategies to identify and exploit price trends.
  • This approach removes emotional bias and allows for consistent execution across markets.

• Flexibility in Positioning

• • Unlike traditional funds, CTAs can go both long and short, potentially profiting in rising and falling markets. 
  • This versatility is critical during market downturns.

• Risk Management Emphasis

• • CTAs use techniques like position sizing, stop-losses, and volatility targeting to maintain consistent risk levels.
• How Can Individual Traders Setup a CTA Strategy?
  • We cover that below.

What are CTAs?

CTAs are professional money managers registered with the Commodity Futures Trading Commission (CFTC).

They specialize in trading futures contracts and other derivatives.

Unlike traditional fund managers, CTAs have the flexibility to take both long and short positions in various markets.

This versatility allows them to potentially profit in both rising and falling markets (or no matter what direction the market is going).

Many traders are interested in studying the CTA business model due to its focus on making the best decisions rather than having systematic bias (i.e., always being long).

Growth in Managed Futures

Managed futures strategies have grown a lot over the past few decades.

Today, the industry manages hundreds of billions of dollars in assets.

Institutional investors, high-net-worth individuals, and even some retail investors have embraced these strategies.

Core Principles of CTA Strategies

CTA strategies are built on several fundamental principles that set them apart from traditional trading or investment approaches.

Trend Following

It’s much more nuanced than saying that CTAs are simply “trend following algos.”

But… the majority of CTAs do use trend-following strategies.

These approaches try to identify and capitalize on persistent price movements across various markets.

Trend followers use algorithms to detect trends early, ride them for as long as possible, and exit when the trend shows signs of reversal.

This systematic approach removes much of the emotional bias often associated with discretionary trading decisions.

And machines are simply better than humans in a lot of ways – data processing, brute-force calculation, following directions, trade execution.

They simply do it faster, more accurately, and less emotionally than any human could hope to.

Diversification Across Markets

CTAs typically trade in a wide range of futures markets.

These may include:

• Commodities (e.g., energy, metals, agriculture)
• Currencies
• Interest rates
• Stock indices (single-stock trading may occur but isn’t necessarily common given CTAs focus on futures markets)

Spreading their exposure across various uncorrelated or mostly uncorrelated markets enables CTAs to try to reduce risk and better smooth out returns over time.

This broad diversification is a key selling point for investors looking to complement their traditional stock and bond portfolios.

Systematic Trading Approaches

Most CTAs rely on quantitative models and computer-driven trading systems.

These systems analyze vast amounts of market data and derive outputs based on however the algorithms are designed.

Systematic approaches try to execute trades consistently and efficiently across multiple markets simultaneously.

How Do CTAs Identify Trends?

CTAs identify trends through a combination of technical analysis and quantitative models. 

Key techniques include:

• Moving averages – Comparing short-term and long-term moving averages to spot trend directions.
• Breakout analysis – Identifying when prices breach significant support or resistance levels.
• Momentum indicators – Using indicators like the Relative Strength Index (RSI) or Moving Average Convergence Divergence (MACD) to gauge trend strength.
• Volume analysis – Assessing trading volume to confirm trend validity.
• Time series analysis – Applying statistical methods to detect persistent price patterns.
• Machine learning algorithms – Using AI to recognize complex trend formations.
• Volatility filters – Adjusting trend signals based on market volatility levels.
• Multi-timeframe analysis – Confirming trends across different time horizons.
• Intermarket analysis – Examining correlations between related markets (i.e., diversification value, what’s discounted across markets).
• Sentiment indicators – Incorporating data on market positioning or investor sentiment.

CTAs often combine these methods, using proprietary weightings and filters. 

For instance, a CTA might combine ~15 different variables based on their understanding of how things work as it relates to their goals, then use that for testing.

As mentioned, they typically execute these trades systematically – executing trades automatically when predefined trend criteria are met. 

Then refining and iterating as they learn and understand more.

Continuous backtesting and optimization on past data and lots of synthetic data help improve these models so that they work well on forward data.

Types of CTA Strategies

Trend following dominates the CTA family, but there are several other approaches used by managers in this space.

Momentum Strategies

Momentum strategies are closely related to trend following but focus on shorter-term price movements.

These approaches try to capitalize on the tendency of assets that have performed well (or poorly) in the recent past to continue that performance in the near future.

Of course, this is not so easy to trade momentum in a discretionary way, so CTAs develop systematic ways of doing it.

Momentum traders may hold positions for days or weeks, as opposed to the months-long holds typical of trend followers.

Momentum tends to align more closely with day trading.

Mean Reversion Strategies

In contrast to trend following, mean reversion strategies bet on prices returning to their historical averages.

These CTAs identify assets that have moved significantly away from their long-term means and take positions anticipating a reversal.

Mean reversion can be effective in range-bound markets where clear trends are absent.

This can also mean that CTAs can be more versatile and not so dependent on a certain environment for making money.

Relative Value Strategies

Some CTAs specialize in relative value trades, which involve simultaneously buying and selling related instruments.

For example, a manager might go long on one commodity future while shorting another in the same sector (e.g., long oil, short gasoline).

These strategies try to profit from price discrepancies while minimizing exposure to overall market movements.

Also important for some institutional traders offering products to investors looking for uncorrelated returns streams.

Option-Based Strategies

A subset of CTAs focuses on options trading within futures markets.

These strategies can include writing options to collect premiums, creating complex spread positions, or using options to hedge other futures positions.

Option-based approaches often try to generate more consistent returns with lower volatility than pure directional strategies.

For those with the expertise, it’s easier to customize returns streams with options/derivatives.

Global Macro Strategies

Global macro CTAs analyze macroeconomic trends and geopolitical events to make directional, non-directional, and relative value bets across asset classes like commodities, currencies, and interest rates.

They use fundamental indicators such as GDP growth, inflation, and central bank policies to predict market movements.

Positions are generally held over medium to long terms.

Volatility Arbitrage Strategies

Focusing on discrepancies between implied and expected future volatility, these CTAs exploit mispricing in options markets.

Strategies include buying undervalued options and selling overvalued ones to profit from volatility differences.

This helps generate returns regardless of market direction.

Machine Learning-Based Strategies

Leveraging machine learning and AI, some CTAs analyze vast data to identify complex patterns and make predictive decisions in real-time.

Seasonality Strategies

Seasonality strategies exploit predictable patterns in commodity prices (mostly, though potentially other assets too) due to factors like weather, agricultural cycles, or consumer demand. 

An example would be CTAs analyzing historical data to identify seasonal trends and positioning accordingly, providing trading opportunities based on established cyclical behaviors and knowing them better than other traders.

Risk Management in CTA Strategies

Managers use various techniques to control risk and protect capital.

Position Sizing and Leverage

CTAs carefully calibrate the size of their positions based on market volatility and the overall risk profile of their portfolio.

Some use risk parity approaches to allocate capital across different markets.

Leverage is often used to improve returns (generally 10-20% annual returns are targeted).

Stop-Loss Orders

Most systematic CTA strategies use predefined stop-loss levels for each trade.

These automatic exit points help limit potential losses on individual positions.

The specific placement of stops varies by strategy, with some managers using fixed percentage stops while others use more dynamic approaches based on market volatility.

Volatility Targeting

Many CTAs try to maintain a consistent level of portfolio volatility over time – for example, 12%, 15%, and 18% are popular targets (15% is roughly the long-run average of the S&P 500).

During periods of high market turbulence, they may reduce position sizes or increase cash holdings.

Conversely, in calmer markets, they might increase leverage to maintain their target risk level.

The general goal is to keep risk and the expected distribution of returns steady over time, which can help smooth out returns and manage drawdowns.

Correlation Management

CTAs try to benefit from the power of uncorrelated returns by trading across markets and without directional bias.

Managers closely monitor the correlations between different positions in their portfolio, adjusting allocations to maintain diversification benefits.

This helps reduce the risk of large drawdowns caused by correlated market moves.

Performance Characteristics of CTA Strategies

CTA strategies have several distinct performance characteristics that attract those looking for diversification and downside protection.

Low Correlation to Traditional Assets

One of the primary appeals of managed futures is their historically low correlation to stocks and bonds.

This characteristic can make CTAs valuable portfolio diversifiers, potentially improving risk-adjusted returns when combined with traditional investments.

Potential for Crisis Alpha

Some CTAs have demonstrated an ability to generate positive returns during periods of market stress.

This “crisis alpha” potential stems from their ability to go short and their focus on liquid futures markets.

Notable examples include CTA performance during the 2008 financial crisis and the COVID-19 market turmoil in early 2020.

Return Profile and Drawdowns

CTA returns can be characterized by long periods of modest gains punctuated by occasional large winning trades.

This return profile, sometimes described as a “long right tail,” reflects the nature of trend-following strategies.

However, CTAs can also experience prolonged drawdowns, particularly during choppy, trendless markets.

Fee Structure

CTAs typically charge both management and performance fees.

Management fees usually range from 1% to 2% of assets under management, while performance fees often fall in the 15% to 20% range.

Some managers use high-water marks or hurdle rates (e.g., needs to outperform cash) to align their interests more closely with those of investors.

How an Individual Trader Can Do a CTA Strategy, Step-by-Step

Choose Your Markets

Select from a diverse range of futures markets to trade.

Include a mix of commodities, currencies, interest rates, and stock indices.

Start with one market, then up to 5-10 markets to keep things manageable.

Develop a Trend-Following System

Create a simple trend-following algorithm.

For example:

• Use two moving averages (e.g., 20-day and 50-day)
• Go long when the short-term average crosses above the long-term
• Go short when it crosses below
• Exit when the trend reverses

First get the hang of writing algorithms and the idea of writing out the logic of your decisions.

Risk Management

Set position sizes based on volatility (e.g., risk 0.5% of your capital per trade)

Use stop-losses (e.g., 2 times the average true range)

Aim for a consistent portfolio volatility (e.g., 15% annualized)

Automate Your Strategy

Use a trading platform that allows automated execution (e.g., TradeStation, NinjaTrader, QuantConnect).

Code your strategy and backtest it thoroughly.

Start Paper Trading

Run your strategy in a simulated environment for at least 3-6 months.

This helps you identify potential issues without risking real capital.

If you can, run synthetic data against it.

Allocate Capital Wisely

When ready for live trading, start small.

Consider using only 20-30% of your trading capital initially.

Monitor and Adjust

Track your strategy’s performance daily.

Calculate key metrics like Sharpe ratio, maximum drawdown, and correlation to major indices.

Adjust position sizes or exit rules if necessary.

Diversify Your Approach

As you gain experience, consider adding:

• Multiple timeframes (e.g., combining daily and weekly signals)
• Other technical indicators (e.g., RSI, MACD)
• Volatility filters to adapt to changing market conditions

Continuous Learning

Regularly review academic research on trend following and CTAs.

Network with other systematic traders to share insights.

Always be testing and refining.

Consider Additional Strategies

Once comfortable with trend following, explore other CTA approaches like:

• Mean reversion trades
• Relative value strategies
• Simple option writing for income

Successful CTA-style trading requires a long-term perspective. 

It’s not about hitting home runs, but consistently capturing small edges across multiple markets. 

Always be prepared for extended drawdowns and recognize that variance is part of it.

Challenges & Criticisms of CTA Strategies

CTA strategies face several challenges and criticisms.

Crowding and Capacity Issues

As the managed futures industry has grown, some observers worry about crowding in popular trades.

With many CTAs following similar trend-following approaches, there’s a risk that large capital flows could impact markets and reduce strategy effectiveness.

This is generally true everywhere.

Periods of Underperformance

CTAs can struggle during extended periods of trendless or choppy markets.

The years following the 2008 financial crisis saw many CTAs underperform as central bank interventions disrupted traditional market trends (e.g., volatility was generally suppressed).

Complexity and Transparency Concerns

The quantitative nature of many CTA strategies can make them challenging for some to understand.

The “black box” perception persists.

This complexity and abstruse nature of what CTAs do can also make it difficult for investors to differentiate between skilled managers and those relying on statistical flukes.

High Fees

The fee structure of many CTA programs has come under scrutiny, particularly during periods of underperformance.

Some investors question whether the potential benefits justify the costs, especially when compared to lower-cost alternative risk premia products that try to capture similar return factors.

The Future of CTA Strategies

As financial markets evolve, CTA strategies continue to adapt and innovate.

Machine Learning and AI

Many CTAs are looking at the use of machine learning and artificial intelligence to improve their trading models.

These techniques may help identify more subtle patterns in market data and improve strategy performance.

Alternative Data Sources

CTAs are increasingly incorporating alternative data sources into their models.

Satellite imagery, social media sentiment, and other non-traditional datasets may provide an edge in predicting market movements.

The challenge is in integrating this information without overfitting models to past data.

Expansion into New Markets

As traditional futures markets become more crowded, some CTAs are exploring opportunities in new areas.

Cryptocurrency futures, for example, have attracted attention from some managers looking for potentially new sources of returns and higher volatility.

Others are looking at less liquid markets or more exotic derivatives to gain an edge.

Customization and Risk Premia Approaches

Investors are demanding more tailored solutions from CTAs.

This has led to an increase in customized managed accounts and the development of risk premia products* that try to isolate specific return factors associated with CTA strategies.

These approaches may offer lower fees and greater transparency than traditional CTA funds.

*Risk premia products in the CTA context are investment vehicles designed to capture specific return factors traditionally associated with managed futures strategies, but in a more systematic and transparent way.

These products typically isolate and replicate key drivers of CTA returns, such as momentum across various asset classes, without relying on discretionary (human) trading decisions.

They often use rules-based approaches to provide exposure to trends in equities, bonds, commodities, and currencies.

Risk premia products usually offer lower fees compared to traditional CTA funds and try to deliver similar diversification benefits.

They’re designed to give investors more targeted exposure to the sources of return in CTA strategies.

Conclusion

CTA managed futures strategies offer a unique approach to trading that can provide diversification benefits and potential downside protection. 

Their ability to trade across a wide range of markets and take both long and short positions sets them apart from traditional trading and investment strategies.