GUIDE TO BECOMING A COMMODITY TRADING …

1 GUIDE TO BECOMING A COMMODITY TRADING ADVISORG uide to BECOMING a CTA1 GUIDE to BECOMING a CTADean E. Lundell Copyright 2004 Chicago Mercantile Exchange2 GUIDE to BECOMING a CTATABLE OF CONTENTS5 AcknowledgementsChapter One7 Market Trends for Alternative InvestmentsChapter Two9 The Business of Being a CTAB usiness Plan and StructureStaffingGrowth ManagementOffice Equipment and TRADING SystemsStart-Up CostsBrokerage Firms and Commission RatesCommissions and ClientsExecution ServicesProfessional ServicesChapter Three15 Creating Your TRADING ProductOverviewMechanical SystemsDiscretionary StrategiesDiversified StrategiesSingle Sector StrategiesStrategy Design and Testing Slippage ControlInstitutional vs. Retail InvestorsChapter Four23 Marketing Your CTA BusinessTrack RecordRaising FundsAccount SizesProfessional Money RaisersClient RelationshipsNational Futures Association RulesChapter Five31 The Measures of CTA SuccessPerformance and Consistency of ReturnsLimiting DrawdownsLength of Track RecordBecoming EstablishedRates of GrowthChapter Six35 Risk Management for CTAsDiversificationRisk per TradePosition Sizes and Risk ExposureTrading in UnitsKick-Out LevelsVolatility Measurement and ControlMargin-to-Equity RatioCommission-to-Equity RatioStop OrdersCommon QuestionsChapter Seven43 CTA Performance RecordsRegulatory RequirementsProprietary Performance RecordSimulated or Hypothetical ReportsComposite Performance

2 RecordsRate of Return CalculationsEstablishing Your Performance RecordChapter Eight47 CTA FeesCompensation ComponentsChapter Nine51 CTA Registration and AuditsRegistration RequirementsDisclosure DocumentsRecord Keeping RequirementsAudit ReadinessGeneral InformationRecordsAdvertising, Communications and Customer ComplaintsFees and Order AllocationPerformance Record TestingManuals and DocumentationExit InterviewChapter Ten59 From Floor Trader to CTAThe Transition from the Floor to UpstairsThe Skills You Have and the Skills You Will NeedGuide to BECOMING a CTA34 GUIDE to BECOMING a CTAA ppendix I63 Risk Control SystemCourtesy, Mr. Thomas BassoAppendix II65 Measuring Futures VolatilityCourtesy, Mr. Thomas BassoAppendix III67 Sample Performance RecordNotes to Performance TableCourtesy, Mr.

3 Michael LiccarAppendix IV71 How to Survive Your First NFA Audit First published in MFA Journal, December 1992By Mr. Thomas P. Schneider, reprinted with permission77 Glossary 81 Index86 ResourcesTable of Contents (continued)ACKNOWLEDGEMENTSTo the consulting firm of Greenwich Associates for supplying facts and figureson alternative investments; to Sol Waksman and The Barclay Group for their indepth analysis of managed futures demographics; and to the Futures IndustryAssociation for their help. Many thanks to Charles Mizrahi, a former floor trader on the NYFE and retiredChief Executive Officer of Hampton Investors, a CTA that he founded. Thanks as well to William Taki who co-founded Baldwin CTA, MC BFC CPOand CF Asset Management, LLC, and is currently co-founding partner andprincipal of CTA, Phoenix Global Advisors, LLC.

4 Thanks also to Stephen Heilman, CME floor trader, CTA and President ofAugustan Capital Management, LLC. Original panels moderated by: Ms. Patricia N. GillmanThis book is an updated version of an original developed in 1994. It is a compi-lation and distillation of remarks made by the following individuals at a series ofseminars hosted by Ms. Patricia N. Gillman and Chicago Mercantile Exchangein May 1992, January 1993, May 1993, September 1993 and March 1994. Manythanks to the following panelists that participated in those seminars: Includedare their credentials at the Greg AndersonCTA and CPOS eptember 1993Mr. Tom BassoCTAJ anuary 1993Mr. Doug BryCTAM arch 1994Mr. David ChevalCTA and CPOMay 1993Ms. Laleen DoerrerMoney RaiserJanuary 1993Ms.

5 Audrey GaleCTA Marketer/AdministratorSeptember 1993Ms. Patricia N. GilmanAttorneyAll SeminarsMs. Malinda GoldsmithCTAM arch 1994Mr. Yra HarrisFloor Trader and Former CTAMay 1993Mr. Joe KrutsingerFCMJ anuary 1993Mr. Michael LiccarAccountant May 1992Mr. Edwin L. MillerCTA and CPOS eptember 1993Mr. Joe NicholasCTA ConsultantMay 1993Mr. Craig PaulyCTA and CPOMay 1992Mr. Jeff QuintoFCMM arch 1994Mr. Thomas P. SchneiderCTAD ecember 1992 How to Survive Your First NFA Audit MFA Journal, Appendix IVGuide to BECOMING a CTA56 GUIDE to BECOMING a CTAA lthough a number of years have passed since those first seminars, the pagesstill offer the reader valuable insights and useful advice on what it takes tobecome a successful CTA ( COMMODITY TRADING advisor ).

6 It is our sincere hopethat you will find value in the wisdom contained in these pages. About the authorThe author, Dean Lundell, has been a Vice President at Merrill Lynch CapitalMarkets, a Principal of a regional investment bank and is, of course, a CTA. Heis the author of Sun Tzu s Art of War for Traders and Investors (McGraw-Hill)and has written numerous publications for private audiences on interest ratederivatives and foreign exchange, corporate and investment banking and thefixed-income markets. The views expressed in this handbook are those of the original panelists and participants andthose who offered their quotes and experience, and do not necessarily reflect the views of CME,its members, employees or contractors. No endorsement of services provided by any of theoriginal panelists or participants or current contributors, employees or contractors is intended byinclusion of their remarks in this handbook.

7 All matters pertaining to rules and specifications aremade subject to and are superseded by official CME rules and applicable COMMODITY FuturesTrading Commission and National Futures Association rules and regulations. TRADING in futures contracts and options on futures contracts is not appropriate for all persons. Itshould never be engaged in by any person who does not have sufficient, accurate and balancedinformation about the investment being considered, including a clear description and explanationof the in this publication are based on hypothetical fact situations and should not be consid-ered investment advice. Some of the items in this publication are based on secondary materialswhich are believed to be reliable, but which are not guaranteed as to accuracy or completeness.

8 This publication was developed for general educational purposes and is not a substitute forany prospectus, disclosure document, or other document that is required to be given toprospective customers. Past performance figures are not necessarily indicative of future returns or Globe logo, Chicago Mercantile Exchange and CME are trademarks of ChicagoMercantile Exchange Inc. All other trademarks are the property of their respective TRENDS FOR ALTERNATIVE INVESTMENTSA lternative InvestmentsAlternative investments can encompass a wide variety of investment vehicles,among which are certain fixed-income instruments, equity real estate, privateequity, hedge funds, and of course managed futures. The trend for institutional participation in alternative markets is clearly on therise on a global basis, with the exception of Japan.

9 Geographic areas thathave seen the greatest expansion in allocations to this broad asset categoryare North America, continental Europe, the United Kingdom and Australia. As of early 2004, allocations to alternative investments, including managedfutures, comprise almost 14 percent of investment dollars in Australia,(although that is a relatively small market), percent in Canada, percentin the United States, 8 percent in continental Europe, and 7 percent in theUnited Kingdom, while Japan lags at only is a wide disparity among institutional investors in regard to the per-centages of funds they have invested in alternative markets, particularlybetween pension funds and endowment funds and foundations. On a globalbasis, endowment funds and foundations are most involved in these markets,with roughly 20 percent of their assets in alternative investments, while pen-sion funds lag this trend significantly.

10 The growth in managed futures over the past 25 years has been truly expo-nential. According to The Barclay Group, which monitors assets under man-agement, CTAs ( COMMODITY TRADING Advisors) were managing $310 million in1980. By 1990, that figure was $ billion; by 2000 it was $ billon and in2003 it totaled $ billion. These figures are echoed in the substantialincreases in TRADING volume on futures exchanges around the TRADING has certainly played a major role in contributing to thisextraordinary growth. There is no mistaking the trend. For more information,visit hedge funds, which have tended to eschew the institutional marketbecause they were unwilling to reveal certain portfolio characteristics, are nowparticipating extensively in managed futures.