Stock and more specifically commodity trading is a high risk investment which should be made only after consultation with independent qualified sources of investment and tax advice. Among the risks involved are the following:
Stock & Futures Trading Is Volatile
A principal risk in stock and futures/commodity trading is the traditional volatility (or rapid fluctuation) in the market prices of stocks and futures/commodities. The volatility of stock and commodity trading may cause a client’s account to lose a portion, all or a substantial amount of its assets in a short period of time. Prices of stocks and commodity interests are affected by a wide variety of complex and hard to predict factors, such as political and economic events, weather and climate conditions and the prevailing psychological characteristics of the marketplace. At SCM we endeavour to manage risk so that in the event of a black swan event or market catastrophe our clients positions are small enough in size where, whilst taking a substantial loss or if the client is luck enough making a substantial profit he or she does not lose their entire investment capital.
Substantial Leverage
Futures/Commodity contracts are traded on margins which typically range from about 2% to 20% of the value of the contract. Low margin provides a large amount of leverage, i.e., commodity futures contracts for a large number of units (bushels, pounds, etc.) of a commodity, having a value substantially greater than the margin, may be traded for a relatively small amount of money. Hence a relatively small change in the market price of a commodity can produce a corresponding large profit or loss. If the Advisor invested a substantial portion of the assets of a client’s account in such a situation, a substantial change, up or down, in the value of the account would result. For example, if at the time of purchase 5% of the price of a futures contract is deposited as margin, a 5% decrease in the price of the futures contract would, if the contract were then closed out, result in a total loss of the margin deposit. Brokerage commissions and other expenses also would be incurred and would have to be paid despite the loss. Thus, like other leveraged investments, any trade may result in losses in excess of the amount invested. Here at Strategic Capital Management seek to only invest a small portion of client funds at any one time and never leverage to the full extent avilable on a clients account.
Stock and Commodity Trading May be Illiquid
It is not always possible to execute a buy or sell order at the desired price, or to close out an open position due to market conditions and/or price fluctuations. As an example of this latter risk, it should be noted that when the market price of a commodity futures contract reaches its daily price fluctuation limit no trades or only a limited number of trades can be executed. Daily price fluctuation limits are established by the exchanges and approved by the ASX, the Commodity Futures Trading Commission (”CFTC”) or relevent regulatory body. The holder of a stock or commodity futures contract may therefore be locked into an adverse price movement for several days or more and lose considerably more than the initial margin paid to establish a position. In certain commodities, the daily price fluctuation limits may apply throughout the life of the contract, and hence the holder of a futures contract who cannot liquidate his position by the end of trading on the last trading day may be required to make or take delivery of the commodity. Another instance of difficult or impossible execution occurs in thinly traded markets or markets which lack sufficient trading liquidity. Stocks can also be placed in trading halts due to the release of information that may affect the stock price. During such situations it is not possible to enter or exit a position when a stock is in a trading halt. As a result, no assurance can be given that the Advisor’s orders will be executed at or near the desired price.
Clients Personally Liable for Losses in Their Accounts
In a managed account, as opposed to a limited liability investment such as a commodity pool, a client’s liability for losses in the account is a direct personal liability of the client. A client’s potential loss is by no means limited to the amount of assets which he commits to the account. For example, in a market in which the Advisor is unable to liquidate positions, clients could lose well in excess of the maximum they had thought they were risking in their stock or futures trading.
Concentration of Positions
The Advisor may concentrate its trading in certain types of stock or commodity interests. Consequently, a client may not maintain a variety of diverse positions. Concentration of trading in certain types of stock or commodity interests may subject the account’s performance to relatively greater volatility than if the account was more diversified.
Reliance on Trading Method Employed by Advisor
The Advisor primarily bases its trading decisions on “technical” factors, such as past price fluctuations of the group or type of commodity. See “Trading Program.” Technical analysis is based on the theory that the study of the markets themselves provides a means of anticipating price movements. Consequently, such analysis does not focus on the forces directly affecting the markets. The technical factors that can be evaluated by an Advisor are limited in that they must be quantifiable in order to be processed by the Advisor. Technical trading methods may also be unsuccessful both because the market models employed are not in fact reliable indicators of future price trends and because the markets are from time to time dominated by fundamental factors. Any factor which may lessen major price trends (such as governmental controls affecting the markets) may reduce the prospect for future trading profitability. Any factor which would make it difficult to execute trades, such as reduced liquidity or extreme market developments resulting in limit moves, could also be detrimental to profits. In short, no assurance can be given that the Advisor’s trading techniques and strategies will be profitable. The best trading strategy will not be profitable if there are no fundamental or technical indicators of the kind it seeks to follow.
Foreign Exchange Risk
Normally accounts will not always be denominated in a clients local currency resulting in an exposure to foreign currency fluctuations. Whilst this risk can be managed to a small degree using forward cover, an unhedged FX exposure can result in a loss on your account if the client local currency gets stronger against the currency the investment is denominated in. Currency fluctuations can be in the vicinity of 15-25% during volatile periods.
Commencement of Trading
An account managed by the Advisor will encounter a start-up period during which it will incur certain risks relating to the initial investment of its assets. An account may commence trading operations at an unpropitious time, such as shortly before a period during which markets have few or no price trends. Moreover, the level of diversification may be lower during the start-up period than in later periods characterized by the commitment of a greater percentage of assets to trading in certain stock or commodity interests. No assurance can be given that the approach which the Advisor chooses to adopt as a means of moving toward full portfolio commitment will be successful or will not result in substantial losses which might have been avoided by other means of initiating such trading in commodity interests.
THE FOREGOING LIST OF RISK FACTORS DOES NOT PURPORT TO BE A COMPLETE
EXPLANATION OF THE RISKS INVOLVED IN STOCK OR COMMODITY TRADING. POTENTIAL INVESTORS SHOULD READ THE ENTIRE DISCLOSURE DOCUMENT AND CONSULT WITH THEIR OWN FINANCIAL AND TAX ADVISORS BEFORE DECIDING TO INVEST.
CONFLICTS OF INTEREST
An investment in an account managed by the Advisor involves risks due in part to certain inherent or potential conflicts of interests. Among such conflicts are the following:
Proprietary Trading of the Advisor
The Advisor and its principal may trade, or will continue to trade, for its own proprietary accounts; such trading may be extensive. There is a conflict of interest between their interest in trading client accounts in order to maximize trading profits for clients and their interest in trading the proprietary accounts in order to maximize trading profits for such accounts. A potential conflict of interest may occur when the Advisor and its principal as a result of a neutral allocation system, testing a new trading system, trading their proprietary accounts more aggressively or any other actions that would not constitute a violation of fiduciary duties, take positions in the proprietary accounts which are opposite, or ahead of, the positions taken for a client. The advisor may also participate in block orders and it may be possible for the Advisor to receive a partial fill on such orders.
Management of Other Accounts by the Advisor and its Principal
The Advisor and its principal may advise other stock or commodity trading accounts, including commodity pools. These accounts may be traded according to the same trading method described herein. Positions held by all client accounts, as well as the proprietary accounts of the Advisor and its principal, will be aggregated for the purpose of applying the speculative position limits. If these limits were approached or reached by trading directed by the Advisor and its principal for their proprietary accounts or other client accounts, an account might be unable to enter or hold certain positions. Such other accounts managed by the Advisor could also compete with an account for the execution of the same trades. Because of the price volatility, variations in liquidity from time to time, and differences in order execution, it is impossible for the Advisor to obtain identical trade executions for all its clients. In addition, certain clients of the Advisor may pay fees to the Advisor, which are higher than that which the Advisor will receive from other clients. As a result, the Advisor will have a conflict of interest between its interest in treating all client accounts alike and its interest in favoring certain clients over others because such clients may pay more in fees to the Advisor. In rendering trading advice to a client, the Advisor and its principal will not knowingly or deliberately favor any other account over the account of a client. No assurance is given that the performance of all accounts managed by the Advisor and its principal will be identical or even similar.
DISCLAIMER
Futures based investments are often complex and can carry the risk of substantial losses. They are not suitable for all investors. The ability to withstand losses and to adhere to a particular trading program in spite of trading losses are material points which can adversely affect investor returns.
The percentage returns above are hypothetical in that they represent the percentage returns experienced in a model account.
The model account rises or falls by the hypothetical compounded profit and loss of trades generated by the system’s trading signals over the test period utilising the money management formula shown above. Returns and drawdowns can increase with a higher level of risk or be reduced with lower levels of risk by adjusting the money management formula for a higher or lower risk (see my blog for more details). The hypothetical model account begins with the initial capital level listed with returns based upon the running total of returns over the period. The % returns reflect inclusion of commissions, fees, and the cost of the system. The monthly cost of the system (if any) is subtracted from the net profit/loss prior to calculating the % return. For systems with one time purchase costs, the monthly cost is calculated by dividing the purchase cost by the number of months in the reporting period.
The main limitation of the hypothetical performance figures shown above is that they assume you can keep compounding to an infinite number of contracts. In practice we would not really be able to continue compounding past 100 contracts. In practice this is overcome by adding additional markets to trade and diversifying the portfolio.
The actual percentage gains/losses experienced by investors will vary depending on many factors, including, but not limited to: starting account balances, market behavior, the duration and extent of investor participation (whether or not all signals are taken) in the specified system, and money management techniques.
CFTC Rule 4.41 – Hypothetical or simulated performance results have certain limitations. Unlike an actual performance record, simulated results do not represent actual trading. Also, since the trades have not been executed, the results may have under-or-over compensated for the impact, if any, of certain market factors, such as lack of liquidity. Simulated trading programs in general are also subject to the fact that they are designed with the benefit of hindsight. No representation is being made that any account will or is likely to achieve profit or losses similar to those shown.
Government regulations require disclosure of the fact that while these methods may have worked in the past, past results are not necessarily indicative of future results. While there is a potential for profits there is also a risk of loss. A loss incurred in connection with trading futures contracts can be significant. You should therefore carefully consider whether such trading is suitable for you in light of your financial condition since all speculative trading is inherently risky and should only be undertaken by individuals with adequate risk capital.
