Drawdowns in Commodity Futures Trading

As Ed Seyokta ( one of the legends of commodity futures trading) would say Drawdowns are like exhaling. If you want to make money in commodity futures trading you will have drawdowns. Drawdowns are a natural part of commodity futures trading. A drawdown is any losing period of a commodity trading advisor or in any commodity trading system. The exact definition is looked at as a percentage retrenchement from a equity high or peak to an equity low. The issue with Drawdowns are not just the retrenchement from the equity highs but the duration of recovery to the equity highs. Depending on the commodity trading advisor or commodity trading system there can be periods that can exceed years. Unfortunately this is the point that too many investors just give up ( many times before the next swing upwards). This enforces that if one wants to be successful in commodity futures trading, two key words are paramount.

Patience and Discipline

The fact is, if an investor has the correct mindset they stand the chance to compound their way to wealth with commodity futures trading. There are no way around drawdowns and volatility. They are a natural point of commodity futures trading. Many times trying to avoid them increases the risks even more so. There is a difference between risk and volatility. In any successful commodity trading advisor or commodity trading system there are risk management systems in place. These do not avoid drawdowns, but attempt to make them manageable. This is one of the main tenants in Trend Following. That is why many times you hear commodity trading managers discuss risk per trade. The lower the risk per trade, the lower the return. Other issues such as risk per sector and open trade equity risk are other variables which effect drawdowns.

One can look at a commodity trading advisors record and even their worst drawdown but the interesting point is the worst drawdown is always ahead of you. An investor who wants to succeed long term must understand this. More so, they need to understand a drawdown can last a VERY LONG time. That is why one needs patience and needs to understand this is a long term endeavor.

Surely not a get rich quick. Rather if you have the mental fortitude to sit through eventual drawdowns you stand the potential to compound your way to wealth. Another idea which I personally use is when a successful commodity trading advisor goes through an eventual drawdown I use this as a point to enter. A real time example is this manager who has been around since 1996 with a compounded rate of return of 17.46%. I entered him with approx 15% drawdown and the next month he rebounded 19.16%. This is not easy. There were several years he did not just not make any money, he lost money. He lost -7.32% one year, another -10.42% and a paltry +4.51% to have a wonderful 43.79% and 62.90% thereafter. These are real audited numbers. This is how it works.

It takes commitment, patience, discipline and proper mindset. You can do this too if you have grow your mental fortitude..

YearJanFebMarAprMayJunJulAugSeptOctNovDecYTD
2009-4.220.81-6.02-4.8419.16 2.90
20084.8812.245.85-7.575.423.22-12.343.969.1511.539.467.04 62.90
2007-0.46-1.77-2.333.691.403.616.48-3.5730.570.592.61-0.12 43.79
2006-3.72-1.993.6418.952.62-5.39-6.76-3.03-3.76-3.756.56-8.05-7.32
2005-1.83-0.18-4.26-1.067.400.13-5.47-1.80-3.32-1.481.400.09-10.42
20040.036.824.88-9.111.31-3.480.12-2.374.730.896.15-4.29 4.51
20032.626.21-7.423.6914.59-3.99-0.55-0.032.753.49-1.485.27 26.21
2002-1.31-3.634.00-2.942.526.113.962.013.80-7.87-2.4016.57 20.50
2001-1.32-2.655.25-9.003.83-5.680.20-2.160.514.49-5.98-0.62-13.32
20002.85-4.57-2.942.969.522.45-7.839.730.47-9.344.6810.48 17.25
19990.876.840.61-1.84-5.995.084.611.040.01-4.576.291.69 14.64
19985.91-0.35-0.41-3.226.40-3.17-0.5621.6711.35-6.101.33-0.77 33.31
19973.818.56-1.140.55-0.13-1.802.43-3.636.11-3.881.615.57 18.65
1996-4.38-0.901.799.10-7.336.870.17-1.1122.079.1015.64-8.64 45.26

Comments

[ValueInvestor:]

Very true article.

Academics like to put volatility and risk in the same category, which might hold true for equities, but not commodities. If aluminum goes from $1.50 /lbs to $0.50 /lbs the vol would be huge but the risk almost zero since $0.50 /lbs is a new historic real low. Commodities can't go to zero, and when they reach historic real lows they're the buying opportunity of a lifetime.

Commodities always revert to their mean, always! It might take a while, but it will happen. You have to have the patience to wait for it to happen.

Jun 22 02:18 PM

[sethmcs:]

Volatility - the magnitude of price movement.
Risk - the probability of events not going as expected.

Forgive me. My definitions.

Jun 22 05:19 PM