THE RISKS OF MANAGED FUTURES INVESTING
By Lou Stanasolovich

Investing in managed futures strategies can involve substantial risks. Listed below are some of the major risks of investing in a managed futures strategy. This means that this list should not be considered exhaustive.

Trading Decisions Are Based On Trends And Technical Analysis:

The buy and sell signals generated by a managed futures trend-following trading strategy may be based upon a study of actual daily, weekly, and monthly price fluctuations, volume variations and changes in open interest in the markets. The profitability of any trend-following trading strategy depends upon the occurrence in the future of significant, sustained price moves in some of the markets traded.

The managed futures manager can incur substantial trading losses:

  • during periods when markets are dominated by fundamental factors (ex. economic factors) that are not reflected in the technical data;
  • during prolonged periods without sustained moves in one or more of the markets traded; or
  • during ’whip-saw’ markets, in which potential prices trends start to develop but reverse before actual trends are realized.

Past history has shown that there have been prolonged periods without sustained price moves in various futures markets. In all likelihood, such periods will recur. A series of volatile reverses in price trends can generate repeated entry and exit signals in trend-following systems, resulting in unprofitable transactions as well as increased brokerage commission expenses.

Futures Markets Are Volatile And Difficult To Predict:

Trading in futures is a speculative activity. Futures prices are often highly volatile. Market prices are frequently difficult to predict and are influenced by many factors, including:

    • changes in interest rates;
    • governmental, agricultural, trade, fiscal, monetary and exchange control programs and policies;
    • weather and climate conditions;
    • changing supply and demand relationships;
    • national and international political and economic events; and
    • the changing philosophies and emotions of market participants.

In addition, governments have been known to intervene in particular markets from time to time, both directly and by regulation, often with the intent to influence prices. The effects of government intervention may be particularly significant in the financial instrument and currency markets, and can cause such markets to move up or down rapidly.

Leverage And Other Speculative Investment Practices Add Risk:

Managed futures managers typically employ some degree of leverage through a number of measures which could increase any loss incurred. The more leverage employed, the more likely a substantial change will occur, either up or down, in the value of the investment. Futures’ trading normally requires low margin deposits to permit an extremely high degree of leverage. This margin requirement may be increased or decreased from time to time by the exchange or the government. Funds involved in futures trading often experience immediate and substantial losses or gains due to relatively small movements in the price of a futures contract.

Markets Can Be Illiquid:

At times, it may not be possible for investment managers to obtain execution of a buy or sell order at the desired price or to liquidate an open position, either due to market conditions on exchanges or due to the operation of "daily price fluctuation limits" or "circuit breakers". For example, most U.S. commodity exchanges limit fluctuations in most futures contract prices during a single day by regulations referred to as "daily price fluctuation limits" or "daily limits."

During a single trading day, no trades may be executed at prices beyond the daily limit. Futures contract prices occasionally have moved to the daily limit for several consecutive days with little or no trading.

Even when futures prices have not moved to the daily limit, the managed futures manager might not be able to obtain execution of trades at favorable prices if little trading in the contracts which the investment manager wishes to trade is taking place. Also, an exchange or governmental authority may suspend or restrict trading on an exchange (or in particular futures traded on an exchange) or order the immediate settlement of a particular instrument. Options trading may be restricted in the event that trading in the underlying instrument becomes restricted.

Options trading also may be illiquid at times regardless of the condition of the market in the underlying instrument. In either event, it will be difficult for the managed futures manager to realize gain or limit losses on option positions by offsetting them or to change positions in the market.

Counterparty Risk:

Another risk with regard to trading in managed futures is what is called counterparty risk. This occurs when trading in over-the-counter (OTC) derivative instruments is conducted with individual counterparties rather than on organized exchanges. There have been periods during which forward contract dealers have refused to quote prices for forward contracts or have quoted prices with an unusually wide spread between the bid and asked price. This can lead to severe losses if cash is required immediately, and the selling party has to dump the contract immediately.

Source: Much of the information for this article was sourced from Man Investments, Inc.

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