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FUTURES MAG

AZIN

E

CONTENTS

6 Ad Index

8 Editors Note From the ashes...

10 Forex Trader NZ dollar is soundest developed country currency heres why

12 Options Strategy Combining long put spreads and short call spreads

46 Trader Profile Ziemba: Leveraging a lifetime of research

DEPARTMENTS

DECEMBER 2013 // VOLUME XLII NUMBER 10

Top 50 Brokers: Bruised and battered, but coming back strong By Ginger Szala & Michael McFarlin Five years ago markets were reeling in the throes of the financial crisis. Since then, Congress has mandated, bad actors have been exposed and futures commission merchants are more efficient than ever, all while swaps are poised to revolutionize the futures industry.

COVER STORY

14

4 FUTURES December 2013

For reprints and e-prints of FUTURES articles, please contact PARS International at [email protected] or (212) 221-9595.

FEATURES

MARKETS20 2014 Hot Markets:

Stuck on taper By Daniel P. Collins Entering 2014, markets are stuck on Fed tapering prospects. Heres which markets to watch for big moves.

TRADING TECHNIQUES

24 Correlated opportunities in the Swiss franc By Nick Mastrandrea The simplest strategies often are the most effective. A pattern just needs to be identifiable and reliable to make money.

28 Using fractals in forex By Leslie K. McNew Heres how to exploit market moves using the Fractal Market Hypothesis and exponential moving averages.

TECHNOLOGY & TRADING

32 Trading system analysis: Then and now By Murray A. Ruggiero Jr. Trading system technology advanced quickly in the 1980s and 1990s. Heres a look at how we got the systems we use today, and where they might go.

TRADING 101

38 10 rules successful traders follow By Jean Folger Although there are numerous trading strategies, following these 10 simple rules can help you get an edge.

MANAGED FUNDS

42 House of AlphaMetrix falls hard and fast By Kristin Fox, Michael McFarlin & Ginger Szala AlphaMetrix made a name for itself with lavish events. Now its making another name for itself. Heres where it stands today.

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EXTENDED INTERVIEWSOur interviews with the heads of FCMs uncovered more than we could fit in our Top 50 Brokers article. Go online for an expanded look into the state of the FCM business.

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From the ashes...

EDITOR'S NOTE


Futures (ISSN 0746-2468) is published monthly by The Alpha Pages LLC, 217 N. Jefferson, Chicago, IL 60661. Subscriber rates in the United States, are one year, $78; two years, $128. All other areas, $121 per year. International online version also available; call 847-763-4945 for details. All orders from outside the United States must be paid in U.S. dollars by international money order only. Single copies $6.95 in the United States, $8.95 in Canada. Periodical postage paid at Chicago, IL and additional mailing offices . Postmaster: Send address changes to Futures Magazine, P.O. Box 1144, Skokie, IL 60076. Allow four weeks completion of changes. CPC IPM Product Sales Agreement No. 1254545. Canadian Mail Distributor information: IBC/Canada Express, 7686 Kimble Street, Units 21 & 22, Mississauga, Ontario, Canada L5S1E9. Canadian Subscriptions: Canada Post Agreement Number 7178957. Send change address information and blocks of undeliverable copies to IBC, 7485 Bath Road, Mississauga, ON L4T 4C1, Canada. Printed in the USA. COPYRIGHT 2013 by The Alpha Pages LLC. All rights reserved. No part of this magazine may be reproduced in any form without consent. CONTRIBUTORS: Return postage must accompany unsolicited manuscripts, photographs and drawings if return is desired. No responsibility is assumed for unsolicited material. Futures Magazine Inc. believes the information contained in articles appearing in FUTURES is reliable, and every effort is made to assure its accuracy, but the publisher disclaims responsibility for facts or opinions contained herein. MICROFILMS and MICROFICHE of all issues of FUTURES are available from University Microfilms Inc., 300 N. Zeeb Ave., Ann Arbor, MI 48106; Information Access Co., 11 Davis Drive, Belmont, CA 94002. The full text of FUTURES is available in the electronic versions of the Business Periodicals Index.

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Its ironic that Im writing this on the day the insurance study commissioned by the industry after the MF Global and PFG blow ups was released. Ironic because if implemented in some form, it would mean more costs and more

rules for futures commission merchants (FCMs) and probably their customers.

Very simply, the studys findings werent ground breaking: Insurance is doable but at a cost. One example of a private option for insurance provided by the FCM would be in a pool of one medium and five small firms, and the cost would range from $3 million to $4.5 million in premiums per FCM per year. After hearing about the expenses FCMs have footed in imple-menting new rules and regulations to be compliant, I doubt they would jump at that option, the one that has the most potential (see Top 50 Brokers: Bruised, battered but com-ing back strong, page 14).

FCMs have taken it on the chin the last few years, and mostly because of others bad behavior. I know all are tired of hearing the names MF Global and PFG, but the fact remains those are the main culprits behind the new customer protection rules.

And its not surprising the FCMs are grumpy about the new rules because they are squeezing firms profitability. A TABB Group study found that of the FCMs they interviewed, addressing regulation remains the most time consuming and energy resource heavy activity. Yet, 43% of FCMs say they do not factor regulations into pricing, while 21% are still evaluating their decisions on how to charge for it.

Although MF Global and PFG customers were violated the most in those demises, collateral damage was spread across the industry: To regulators, to exchanges, and yes, to other FCMs. Perhaps some brokers may have gotten some new customers, but it probably netted out in the end with other clients leaving due to lack of confidence in a system that had operated fairly well for years.

So an insurance program, which is admirable and may work one day, probably isnt a priority for a group of firms that already believe theyve complied and spent a lot of money to do so. Also, with new customer protections in place, insurance might be a redundancy that isnt necessary.

Furthermore, it might not accomplish what it is meant to do protect and reimburse customers. According to the Compass Lexecon, the group that did the study, the most positive private option would depend on the amount of the total customer asset loss. If, for example, the FCM had $100 million in losses, and was insured up to $50 million, customers would only get 50% of their money back. The government-mandated option might be so poorly funded that in PFGs case only 12% of customer loses would have been covered. So the industry has some talking and deciding what to do. But after hearing from our panel of FCMs, my belief at this point is 1) the insurance study findings just came out so its too early to make any determination, and 2) that said, I highly doubt FCMs want to absorb more costs.

This is especially true with news that came out in early November that the CME Group would be implementing new and higher fees. Thats another story. But we did ask the FCMs what the impact of fewer futures exchanges had on their busi-ness. Many thought it made life easier as far as connectivity and systems, but they rue the lack of competition between exchanges. One FCM that also is in the equity options space, which has close to 13 exchanges, notes that a high number of exchanges can be a headache, but it sure keeps fees competitive.

The good news is that after the last several years, including the 2008 financial crisis, most FCMs see daylight from imple-menting new rules and are actually optimistic; finally they can get back to what they do best: Execute, trade and make money.

E-mail me at [email protected]

TradeStations tools help you spot opportunitiesbefore other traders do. See for yourself. Go toTradeStation.com and take the TradeStation Tour.

1.800.264.8516 | TradeStation.comNo offer or solicitation to buy or sell securities, securities derivatives, futures products or off-exchange foreign currency (forex) transactions of any kind, or any type of trading or investPent advice, recoPPendation or strategy, is Pade, given or in any Panner endorsed by any 7rade6tation af liate 7rading coPPodities futures, options and off-exchange foreign currencies carries a high level of risk and Pay not be suitable for all investors 7here is a possibility that you Pay sustain a loss eTual to or greater than your entire investPent therefore you should not invest or risk Poney you cannot afford to lose 3lease visit our Zebsite ZZZ7rade6tationcoP for relevant risk disclosures (Tuities, eTuities options, and coPPodity futures products and services are offered by 7rade6tation 6ecurities, ,nc (0ePber N

With most developed nations opting to debase their currencies, the Reserve Bank of New Zealand is going the other way and preparing to raise interest rates and keep inflation low. As a result, the New Zealand dollar stands out as one of the lone buying opportunities. The country of New Zealand is politically stable, has exports in underval-ued agricultural assets, a favorable business climate and most importantly, is the only developed nation seriously inclining toward raising interest rates.

The primary case for buying the New Zealand dollar is the Reserve Bank of New Zealands likelihood of raising interest rates. With New Zealands GDP growth rate much higher than other Western nations (2.6% vs. 1.6% in the U.S. and 0.6% in the European Union), and inflation accelerating to a 3.6% annual-ized pace in the second quarter of 2013, the country has the flexibility to raise rates. Because of growing inflation pressures, rates are expected to rise as early as March 2014.

The increasing strength of the New Zealand dollar also will be a product of continued easy money elsewhere. With the Australian economy slowing down because of less commodity exports, the European debt crisis, continued Abenomics related stimulus and the Feds refusal to back down on unlimited QE, no other developed nation will be raising rates in the intermediate-term. Slow growth in these countries also is bearish for their currencies.

Even if developed economies recover, interest rates will not rise because the central banks are using their easy policies not as a mea-sure of economic stimulus, but actually as a tool to monetize their countries debt burdens. Central bankers deny this, but without this financial repression, borrowing costs would be too high for these countries to finance their government spending without default or politically unacceptable reductions of the social welfare state. Because New Zealand has a debt-to-GDP ratio of only 36%, higher interest payments do not cripple its sovereign finances. The end result is that the New Zealand dollar will replace the Australian dollar as the high-yield currency in carry trades and will be the only place where bank deposits will yield a positive real return.

New Zealands economy also is on a stable footing. The country has some of the worlds highest degrees of economic freedom (ranked 4th by the Heritage Foundation) and lower personal and corporate income tax rates (33% and 28% with dividend imputa-tion respectively) than the United States. Exports mostly consist of agricultural and livestock products that are recession-resistant consumer durables. New Zealand also is one of the beneficiaries of the growth of meat and dairy consumption in Asian markets. Low population density and a highly educated population also are bullish signs for New Zealands economic sustainability.

Overall, outlook is strong on the New Zealand dollar because of the likelihood of increased capital inflows resulting from higher rates and economic stability. With markets at stretched

valuations, global inves-tors need a place to store their cash. New Zealand is one of the few places with a credible banking system, low cor-ruption and economic stability where an investor can do that while having a positive real return on deposits.

Nicholas Pardini is founder and managing partner of investment firm

Nomadic Capital Partners, which specializes in investing in emerg-

ing and frontier markets around the globe. His book, The Definitive

Guide to Emerging Market Currencies, was written in response to

his inability to find research on the subject. You can reach him at

[email protected].

NZ dollar is soundest developed country currency and heres why

BY NICHOLAS PARDINI

FOREX TRADER


For daily forex updates:futuresmag.com/Forex

COUNTRY STRONG

STEADY AS SHE GOES

Source: eSignal

Source: Statistics New Zealand, The Treasury

Jul 2011 Jul 2012 Jul 2013 Jul

2012 2013 2014 2015 2016 2017

0.90000

0.88000

0.86000

0.84000

0.82000

0.80000

0.78000

0.76000

0.74000

0.72000

0.70000

0.68000

0.66000

6

5

4

3

2

1

0

-1

-2

-3

-4

0.82540

New Zealand dollar (spot) weekly

Percentage point contribution

Years ended March 31

Even the IMF has commended New Zealand on its economic plan.

New Zealands GDP is projected to run 2%-3% for the next four years.

w

Exports

Non-residential investment & stocks

Imports

Residential investment

Total GDP (annual average growth %)

Total consumption

BREAKINGBREAKING NNEWEWS

EEE CLUSIVEXCLUSIVE RREPORTS &EPORTS & AANALYSISNALYSIS

E CATIONDUCATION

TRADING RADING SS ATEGIESTRATEG

L VE MARKEIVE MARKET UPDATESP

THEE 24/7 RESSOU24/ RESOURRCE FOCE FORR TODAYS TODAYS TRRADEADERSS

Now that the markets are at all-time highs, most people cant help but think of the idiom erroneously attrib-uted to Isaac Newton: What goes up must come down. Regardless of your opinion as to where the final destination of

this market move will conclude before reversing, you cannot help but worry about the three blind mice coming our way in 2014.

Trifecta events1. Fed stimulus taperHistorically, the market crashes within six months of a dramatic negative Fed policy change. We have had many false tapering alarms, but the markets are almost certain March will be the taper. 2. Government shutdown part II Though known as a farce by the majority of the world, the fear of the unknown is a negative for the market. The last shutdown saw the Dow fall from 15,700 to 14,800. 3. New Fed chairmanAlan Greenspan took office on Aug. 11, 1987, and Black Monday occurred on Oct. 19. Ben Bernanke took office on Feb. 1, 2006, and two years later we had the world banking collapse. Whats in store for Janet Yellens baptism?

Here is a riddle: Will the laws of physics dictate that this mar-ket in bullish motion remains in motion, or will an inevitable retrenchment occur?

ProblemMost option traders know the benefits of a vertical spread over that of a naked option. If bearish in opinion, many option trad-ers will contemplate the purchase of a long put spread or the sale of a call spread. Long Put SpreadSimply purchasing a put spread to take advantage of a possible decline can be costly if the selling doesnt occur or is not strong enough. The market could decline and the spread still would expire worthless. Short Call SpreadSelling a call spread can work out nicely, but selling an out-of-the-money $5 or $10 wide index call spread at $1 or $2 is not the bang for the buck option traders look for in large moves.

Solution: The risk reversalStrategically combining the long put and short call verticals into one position can be a forgiving and powerful position that affords the trader patience and more flexibility than utilizing one spread alone.

Both spreads usually will be constructed with out-of-the-mon-

ey options. Having an out-of-the-money call spread provides room for further stock advances without the short (bearish) spread going in-the-money. Having an out-of-the-money put spread allows for a less expensive entry cost, thus providing more potential profit.

For example, lets assume that the Dow Jones Industrial Average is at all-time highs and trading at 15,900. The proxim-ity to 16,000 may be enough to frighten people without the economic and political events on the horizon. To have a position on with some time to breathe, we can go out into the 45 days until expiration expiry in the SPX when the SPX cash is at 1795.

The net credit received on the short 1855-1850 call vertical spread ($5.20+$6.20=$1.00) completely offsets the debit paid for the 1750-1745 Put spread ($17.30+$16.30=$1.00). Should the market glide slightly higher, remain constant or fall only slightly, the position simply expired worthless with no loss other than commissions.

Option traders who appreciate both long and short vertical spreads will find it difficult not to appreciate the alchemy cre-ated when combining the two strategies. This particular strategy affords time and forgiveness to the trader who is not able to pick the exact moment when the market reverses.

J.L. Lord is an analyst and author at RandomWalkTrading.com, a

trading education firm employing retired floor traders (only) as their

instructors. He can be reached at RandomWalkTrading.com.

Question: How can I protect myself when upcoming events could rock the market?

Answer: Use a risk reversal: Long put spread combined with short call spread.

BY J .L . LORD

OPTIONS STRATEGY

For more options strategies: futuresmag.com/Options


PUT SPREAD & CALL SPREAD

Source: RandomWalkTrading

$1500

$1000

$500

$0

-$500

-$1000

-$15001720 1730 1740 1750 1760 1770 1780 1790 1800 1810 1820 1830 1840 1850 1860 1870

Price of Standard and Poors 500 cash (SPX)

Short 1850 1855 Call spread

PPPPPPrrrrrrroooooooofffffffffiiitttttttttttttt AAAAAAAArrrrrrreeeeeeeaaaaaaa

LLoooossssssssss AAAAAAAAArreeeaaa

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T O P B R O K E R S

For the derivatives industry, the financial crisis volatility that many survived was hit with customer confidence issues caused by the failures of MF Global and Peregrine Financial Group. With the new customer protection rules released by the Commodity Futures Trading Commission (CFTC) in October, the mandated residual interest rule was put in place.

This rule basically forces brokers to shorten the current time they collect margin from customers to one day, and in five years, to the following morning. Although many firms are electronic, hence collect payments at T+0 and T+1 rates, some have a large group of clients that still write checks. To make this change would mean pre-payment of the account, something that could curb usage of the futures markets. But, as Mike Dawley, managing director of global futures and OTC clearing securities division of Goldman Sachs, noted on an FIA Expo panel, who knows who will still be around

in five years? This highlights what many in the industry believe, that T+0 will never happen, although T+1 is a good bet. Don Roberts, managing director of futures & forex for ThinkorSwim, the derivatives arm of TD Ameritrade, summed it up that the regulator (like Congress) kicked the can down the road.

This is only one of the many issues on which we questioned a score of top futures commission merchants (FCMs) to discuss

for our annual review. New regulations and compliance issues have become such the focus the last few years in the business, brokers seem to finally see the light of day and are getting back to real busi-ness. Matthew Simon, senior analyst and head of futures research at TABB Group, which just completed its annual FCM study, noted that after the past few years with the failure of MF Global and PFG, the shrinking volumes, low interest rates and continuous money flowing out to keep up with compliance, this year we found more optimism, he says. Not so much that volumes will grow [rapidly], but that efforts put in terms of [futurization of swaps], and that rules that were talked about for years are now a reality and [FCMs] can get back to making money on executing trades.

And hes correct, except that there still is some anger about some of the regulations. Joe Guinan, chairman and CEO of Advantage Futures, believes despite being one- and five-years

Bruised and battered, but coming back strongBY GINGER SZALA & MICHAEL MCFARLIN

TRADE TRENDS

Five years is a long time. Think about it: In 2008, the financial markets were in upheaval, still reeling from the failure of Lehman Brothers and the infamous bail-out of the too-big-to fail firms. Since that time the U.S. Congress wrote and passed the Dodd-Frank Wall Street Reform and

Consumer Protection Act, mandating that the various regulatory agencies put

in place rules that would stem some of the bad behavior that happened during

the financial crisis. A lot, it seems, can change in five years.

futuresmag.com 15

out, the residual interest rules border on ridiculous. [For the full transcripts of many of these interviews, go to www.futures-mag.com/2013fcmspeakout.]

The impact will be for FCMs to require customers to hold larger excess balances to avoid margin calls, causing a negative capital impact to the FCM even from relatively minor market move-ments and position marks. This increase in margin required by FCMs effectively raises the clients cost to trade. The need to resolve margin calls more quickly will tend to increase volatility at exactly the wrong time (during extreme market moves) as the FCM will be forced to liquidate more quickly (rather than take the appropriate time and do it in an orderly manner). The rule also will preclude people from initiating positions that may serve to temper a big market move (for fear of generating margin calls) big moves in any market will be exacerbated by this rule. Intuitively, regulators should want to help foster liquidity that can dampen extreme mar-ket moves. This rule will force more intraday liquidation to avoid margin calls whenever a severe market movement occurs; some market segments may utilize alternative markets (cash or spot, forward, etc.) to hedge risk rather than deposit the extra funds, further reducing futures liquidity, Guinan explains.

Gerry Corcoran, chairman and CEO of R.J. O Brien & Associates, says We believe the residual interest rule went too far, adding, This likely will have a profound impact on those in the agricultural community even before the at all times phase-in after five years which is very unfortunate.

Scott Gordon, chairman and CEO of Rosenthal Collins Group, agrees. As currently constructed with the phase-in provision, we have to be mindful of the prospective impact on clients whose livelihoods make it difficult to comply with the provisions. For example, smaller commercial hedgers, and also international clients, may have operational difficulty posting funds with their FCM to comply with the new deadlines being phased in.

And despite the tightening of rules it might appear to be, says Tom Kadlec, president of ADMIS, its yet another cost for the customer. Over time, the rule will increase the amount of capital required to be maintained by FCMs, which will decrease our returns. It also will increase the frequency of wire transac-tions and the amount of customer funds posted at FCMs, and

increase the cost of hedging for mid-level accounts. This will possibly drive customers to other risk management products such as crop insurance or off-loading production to large pro-cessors earlier in the cycle to avoid increased hedging costs.

The irony, muses TDs Roberts, is if these rules were written due to the MF Global and PFG messes, Peregrine would have asked you to prefund your account, [and] would have stolen more. Instead of $200 million, [PFG] would have walked out with $400 million. [Jon]Corzines positions would have been exponentially larger. Hes glad the regulator is taken iterative steps with this rule to make sure it helps rather than hurts the business.

Granted, this is one rule of many, but when asked about how the Dodd-Frank rules impact their business overall, all FCMs were vocal. Keep in mind, according to the TABB Study, which interviewed 16 U.S.-based FCMs, of which represented almost 75% of the $157.7 billion in total seg funds, addressing regulation remains the most time-consuming and energy-resource-heavy activity, the report states, adding, Yet, 43% of FCMs say they do not factor regulations into pricing, while 21% are still evaluating their decisions on how to charge for it. For a business that has razor-thin margins, regulation always has raised blood pressures.

Guinan, always to-the-point, notes, There are now manda-tory and severely punitive fines for irrelevant, immaterial rule violations that in times past were handled more reasonably. Not long ago, exchanges and regulators employed a reasonable man yardstick in evaluating mistakes made by an FCM. If an investiga-tion revealed a minor human error had occurred and there was no pattern of negligence or deception, fines were usually set to a level acknowledging the error and economically encouraging FCM actions to minimize any recurrence. Now, in the aftermath of the great recession, the overarching regulatory goal seems to be to fine every firm and market participant as much as possible for any infraction that can be identified. Their need not be malice or mal-intent or negligence a simple minor human error can now be met with a severe financial penalty. Over time, this will cer-tainly result in higher commissions and costs for clients as FCMs will be forced to pass along this higher regulatory operating cost.

Dan ONeil, vice president of futures at optionsXpress, agrees. The other big story is that the penalties for being non-compliant

After years of dealing with low interest rates, new regulations and rebuilding client

confidence, futures commission merchants are ready to break out and start doing

what they do best: Executing trades and hopefully making money. In our annual

review of the industry, we found frustrations with compliance and regulations still,

but also: Optimism.

are now more severe than ever before. The steady drumbeat of new rules and regulations combined with the seriousness of being non-compliant means firms are focusing intently on this sort of thing.

You might be familiar with a recent ruling that requires all futures industry participants to record and archive all communications that lead to the execution of a futures order, and that is presenting a number of problems for firms. Theres been very little interpretive guidance from the regulators as to what this means exactly, but were working hard on that right now.

Kadlec agrees about the need for guidance: The CFTC, NFA, and the exchanges could help immensely with this by putting out guidance letters and white papers that bridge the gap between theo-retical rules and the practical implementation of the new rules.

Enter the SWAP teamsA new rule that bodes well for the business is the move of the OTC swaps to be cleared via swaps execution facilities. And this, according to the TABB Group report, could be a boon for the industry. Of the FCMs that TABB interviewed, most saw this as a major growth opportunity for them; in fact, it could mean a 15% increase in revenues. The futurization of the swaps markets could be very good indeed for those firms who are approved, or are planning to be approved, swaps dealers. This includes typically the largest of the firms, such as Newedge, which was in the first 18 firms to be approved, to mid- to large-firms, such as FCStone Group. But for mid- to small-sized firms, the swaps business may be good for their larger brethren, but wont be an area they have clientele. Even some mid-sized firms, such as TradeStation, cater mainly to retail business, so swaps arent an area for growth.

Says Newedges new CEO David Escoffier: The futurization of swaps as well as OTC clearing are both major growth drivers for us.

Clients have turned more and more to deliver-able swap futures and we are actively engaged with the respective CCPs as well as new provid-ers and new exchanges such as GMEX and Eris. Overall, the futurization of swaps is completely synergistic to our business and as the market leader in clearing of listed derivatives, we wel-come this trend.

Pete Nessler, CEO of FCStone Group, also believes this is a growth area for his firm, largely because they have a sizeable ag clien-tele that does swaps. He notes they already have seen large increases in block trading.

TABB found that 90% of their respon-dents believe swaps hold the potential to bring new liquidity to the futures markets, and in fact, the firm estimates swap futures will capture 3% of the swaps market, mean-ing huge growth, especially in the interest rate futures contracts. TABB reports some respondents already see a slowing down of the OTC desk business as the expenses of the OTC products increase.

So is there growth for non-swap firms? Apparently, yes. TD Ameritrade, which purchased ThinkorSwim in 2009, has seen huge growth in the appetite of its equity trader-clientele base for derivatives. Steve Quirk, executive vice president, notes that when they were first bought by TD Ameritrade, the group brought in about 9% of the revenues. Today they account for 40%, and the main growth has been by providing current equity clientele derivatives products. ONeil echoes the sentiment with optionsXpress parent Charles Schwabs clientele that is looking to hedge portfolios or trade derivatives.

Carl Gilmore, CEO of KCG (Knight Capital Getco), agrees with this growth potential. Of course swaps are one thing, but the traditional futures space needs to do a better job as an industry telling our story to the world. The metric that always gets used is that futures activity is about 8%-9% of all activity in the capital markets in this country. So, if we were to expand the users of our markets by 5% and go to 13%, then the industry is now 50% bigger. I tend to see traditional market participants coming back in, including retail traders that had been on the sidelines.

TABBs Simon even sees this in the institutional space. More traditional asset managers are seeing the benefit of using deriva-tives; many are starting up derivatives trading desks.

But others see growth internationally, and as Simon notes, when we ask where investors want to go, China is by far the number one request.

Many of the mid-level firms on our panel agreed they were or already have ventured into other regional arenas. Some have a built-in business opportunity with sister or parent compa-nies, such as ADMIS and FCStone. Other firms, such as RJO, Advantage and RCG, have looked east and west to expand. And on potential product growth, several saw options on futures as


TOP BROKERSBBBBB O continued

Despite the total customer assets remaining relatively level since mid-2011, the number of FCMs has dropped, although some see that amount leveling off.

DIVERGENCE IN THE NUMBERS

175

165

155

145

135

125

115

105

95

85

75

Dec

-07

Mar

-08

Jun-

08

Sep

-08

Dec

-08

Mar

-09

Jun-

09

Sep

-09

Dec

-09

Mar

-10

Jun-

10

Sep

-10

Dec

-10

Mar

-11

Jun-

11

Sep

-11

Dec

-11

Mar

-12

Jun-

12

Sep

-12

Dec

-12

Mar

-13

Jun-

13

Sep

-13

Dec

-13

200

180

160

140

120

100

80

60

40

20

0

Number of FCMs & customer asset totals, December 2007 December 2013

Customer funds # FCMs

September 2008,Lehman Brothers September 2011,

GlobalJuly 2012,Peregrine

134 133

122116

114

10195

Source: CFTC, TABB Group

Top Brokers continued on page 23

Go to futuresmag.com/topbrokers for an unabridged version of this interview.

futuresmag.com 17

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2013 Rank1 GOLDMAN SACHS & CO.[6] 9/30/13 18,786.75 1 19,941.28 16,666.73 8,217.70 0.00 Y I2 JP MORGAN SECURITIES LLC[7] 9/30/13 17,323.09 2 18,272.15 21,418.57 3,619.16 0.00 Y I3 DEUTSCHE BANK SECURITIES INC 9/30/13 13,997.23 4 14,828.21 7,271.03 925.11 0.00 Y I4 NEWEDGE USA LLC 9/30/13 13,725.67 3 16,470.66 1,807.01 3,016.53 0.00 Y DND DND I N5 MERRILL LYNCH PIERCE FENNER & SMITH [8] 9/30/13 9,696.05 6 8,342.40 13,998.34 2,396.85 0.00 Y DND DND Both Y6 MORGAN STANLEY & CO. LLC [9] 9/30/13 9,532.48 8 8,157.68 11,110.12 2,386.48 0.00 Y7 UBS SECURITIES LLC [10] 9/30/13 8,179.55 5 9,070.17 10,742.12 4,382.49 0.00 Y8 CREDIT SUISSE SECURITIES (USA) LLC 9/30/13 7,078.47 9 6,374.16 8,392.25 3,077.41 0.00 Y9 BARCLAYS CAPITAL INC 9/30/13 7,068.90 10 5,904.94 6,377.01 3,838.19 0.00 Y DND DND DND DND

10 CITIGROUP GLOBAL MARKETS INC 9/30/13 6,195.37 7 8,018.19 6,343.81 929.13 0.00 Y11 RJ OBRIEN ASSOCIATES LLC 9/30/13 5,526.56 11 4,001.52 192.63 147.75 1.34 N12 BNP PARIBAS PRIME BROKERAGE INC[11] 9/30/13 3,303.92 19 1,768.41 4,953.87 1.54 0.00 Y13 ADM INVESTOR SERVICES INC 9/30/13 2,904.91 12 2,975.11 274.21 157.03 0.00 N DND DND Both Y14 INTERACTIVE BROKERS LLC [12] 9/30/13 2,692.81 14 2,320.72 2,391.99 291.46 40.06 Y 17,350.00 193.47 Both N15 MIZUHO SECURITIES USA INC 9/30/13 2,284.50 20 942.78 426.53 388.34 0.00 Y DND DND I N16 ABN AMRO CLEARING CHICAGO LLC 9/30/13 2,215.11 15 2,227.72 474.25 100.30 0.00 Y17 JEFFERIES BACHE LLC 9/30/13 1,916.26 13 2,580.00 204.36 124.06 0.00 N18 FCSTONE LLC 9/30/13 1,669.64 18 1,620.50 106.29 59.84 0.00 N DND 48.10 Both Y19 ROSENTHAL COLLINS GROUP LLC 9/30/13 1,432.78 17 1,625.07 75.49 27.30 0.00 N DND DND Both Y20 RBS SECURITIES INC 9/30/13 1,401.01 16 1,704.88 4,352.65 94.29 0.00 Y21 MACQUARIE FUTURES USA LLC 9/30/13 1,277.86 23 736.55 144.55 23.49 0.00 N DND DND Both N22 HSBC SECURITIES USA INC 9/30/13 924.07 22 857.96 1,004.44 73.93 0.00 Y23 RBC CAPITAL MARKETS LLC 9/30/13 895.78 25 581.27 1,099.50 121.82 0.00 Y24 MCVEAN TRADING & INVESTMENTS LLC 9/30/13 786.67 21 940.34 12.90 0.00 0.00 N DND DND Both Y25 SANTANDER INVESTMENT SECURITIES INC 9/30/13 672.03 27 534.84 217.36 0.00 0.00 Y26 KNIGHT CAPITAL AMERICAS LLC [13] 9/30/13 477.58 30 425.82 356.70 7.86 38.86 Y27 ADVANTAGE FUTURES LLC 9/30/13 476.34 29 446.90 21.71 32.75 0.00 N DND 250.23 Both Y28 VISION FINANCIAL MARKETS LLC 9/30/13 470.62 26 538.37 34.26 14.29 0.00 Y DND 23.97 Both Y29 TRADESTATION SECURITIES INC 9/30/13 398.59 32 389.20 58.71 15.81 0.00 Y 14.48 8,994.26 Both N30 RAND FINANCIAL SERVICES INC 9/30/13 300.82 31 389.56 79.31 9.01 0.00 N DND DND I N31 STATE STREET GLOBAL MARKETS LLC 9/30/13 217.92 36 141.40 531.67 23.05 0.00 Y32 EFL FUTURES LIMITED [14] 9/30/13 198.01 33 292.10 41.07 0.00 0.00 N33 E D & F MAN CAPITAL MARKETS INC 9/30/13 181.78 NA NA 27.92 1.84 0.00 Y34 CHS HEDGING INC 9/30/13 150.32 37 141.03 26.20 0.25 0.00 N DND DND Both N35 GAIN CAPITAL GROUP LLC [15] 9/30/13 136.20 40 106.59 44.05 3.26 105.6 RFD36 DORMAN TRADING LLC 9/30/13 134.45 38 138.43 11.12 1.95 0.00 N 2.50 32.00 Both Y37 STRAITS FINANCIAL LLC 9/30/13 131.06 45 78.51 9.51 21.96 0.00 N38 TD AMERITRADE INC 9/30/13 117.28 41 102.91 305.07 0.00 0.00 Y39 BNY MELLON CLEARING LLC 9/30/13 116.56 35 144.59 285.89 15.99 0.00 N40 PHILLIP FUTURES INC 9/30/13 105.91 34 185.46 28.12 2.95 0.00 N41 MAREX NORTH AMERICA LLC 9/30/13 88.00 43 89.42 11.64 6.83 0.00 N 33.08 DND I Y42 OPTIONSXPRESS INC 9/30/13 81.59 42 98.55 99.73 1.07 0.00 Y43 CROSSLAND LLC 9/30/13 78.42 47 67.75 9.20 6.87 0.00 N44 THE LINN GROUP 9/30/13 75.54 44 80.40 3.53 0.08 0.00 N45 CUNNINGHAM COMMODITIES LLC 9/30/13 64.81 46 73.35 2.92 0.40 0.00 N46 VELOCITY FUTURES LLC 9/30/13 59.83 49 58.06 1.26 0.80 0.00 N 1.20 12.00 Both N47 NOMURA SECURITIES INTERNATIONAL INC 9/30/13 55.45 50 51.40 1,567.45 0.81 0.00 Y48 YORK BUSINESS ASSOCIATES LLC [16] 9/30/13 50.51 48 63.97 4.96 1.92 0.00 N49 AMP GLOBAL CLEARING LLC 9/30/13 42.65 NA 36.04 2.45 0.43 0.00 N50 IRONBEAM INC 9/30/13 37.83 NA 50.59 2.28 0.00 0.00 N

[1] Customer equity represents the total amount of funds that an FCM is required to segregate on behalf of customers who are trading on a registered U.S. futures exchange. This is the sum of all accounts with a net liquidating equity and is reported to the CFTC. 4d(a)(2)

[2] A firms Adjusted Net Capital is the amount of regulatory capital available to meet the FCMs minimum net capital requirement. The classification of assets and liabilities used in arriving at net capital, and the additional capital haircuts that an FCM may be required to take, are set forth in CFTC Regulation 1.17.

[3] Secured amount represents the amount of funds an FCM is required to set aside for customers who trade on futures exchanges located outside the United States. Part 30.

[4] Non-U.S. customer equity is the amount of funds FCMs hold for traders outside of the United States. This was obtained from the FCMs on a voluntary basis. It is not reported to the CFTC.

[5] This is the number of trades cleared by the listed firm through September.[6] Goldman Sachs & Co. includes amounts from Goldman Sachs Execution and Clearing LP.[7] JP Morgan Securities LLC includes amounts from JP Morgan Clearing Corp.

[8] Merrill Lynch, Pierce, Fenner & Smith Incorporated includes amount from Merrill Lynch Professional Clearing Corp.

[9] Morgan Stanley & Co. LLC includes amounts from Morgan Stanley Smith Barney LLC.[10] UBS Securities LLC includes amounts from UBS Financial Services Group.[11] BNP Paribas Prime Brokerage Inc. includes amounts from BNP Paribas Securities Corp. [12] Interactive Brokers LLC includes Timber Hill LLC. RBC CM LLC formerly was known as RBC Capital Markets.[13] Knight Capital Americas LLC was acquired by Getco and will be known as KCG.[14] EFL Futures Ltd. was formerly known as Enskilda Futures Ltd.[15] Open E Cry LLC is a a subsidiary of GAIN Capital Holdings[16] York Business Associates LLC is doing business as TransAct Futures (TransAct). DND Did not disclose NA Not applicable

FO

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H O T M A R K E T S

MARKETS

2014 Hot Markets: Stuck on taperBY DANIEL P. COLLINS

When U.S. financial markets finished their temper tantrum over the Federal Reserve

acknowledging that QE3 would have to end, the prospects of more rational market

fundamentals emerged. But as we enter 2014, markets appear stuck on taper.

One of the frustrating elements for traders since the 2008 credit crisis slashed value is the way markets have traded and reacted to fundamental news. There were no trends, just a constant risk-on/risk-off world where opportunity gave way to fear and fear to opportunity, not so much based on the analysis of mar-ket fundamentals but on how the Federal Reserve and other central banks would manage the so-called new normal.

This appeared as if it may give way this summer as the Federal Reserve acknowl-edged that the open-ended quantitative easing (QE3) launched in 2012 would have to come to an end. The plan was to begin tapering the $85 billion in monthly fixed income purchases near the end of 2013 and get down to zero by mid-2014.

Treasuries: Is end near?It turns out the anemic recovery of the last few years was not quite ready to fly on its own and even if it was, political dysfunc-tion may have thrown a monkey wrench into those plans by threatening the world with a self-made economic crisis. While a series of political missteps may have delayed

the onset of taper, its inevitability makes Treasuries the most interesting market going forward and adds to the possibility of two-way volatility.

It will be an interesting market going forward in the same way it was in 2013, but I dont think it is necessarily because the bull market will end, says Andrew Wilkinson, Miller Tabaks chief economic strategist. The market still has to come to terms with the Feds forward guidance. The market still has to come to terms with the lack of inflation and the breakdown in cor-relation between commodity prices and the value of the dollar.

Treasuries overreacted to the initial taper scare in May and since have frustrated those waiting for the 30-year-plus bull trend to end. I dont think that the Treasury bull market is over. You have to recognize that we really are living in a new normal and we have a fiscal headwind restraining the economic recovery and that there is a lack of infla-tionary pressure that is going to maintain a steady cap on interest rates, Wilkinson says. It is very noticeable that the 10-year yield got down to 2.46% since the September non-taper meeting. I dont think that nec-essarily is because the economy weakened substantially. [It] is because the Fed has been successful reaching an increasing number of

investors with its message that even beyond finalizing its asset purchases the Fed Funds rate will not increase.

Wilkinson, who sets the range in 10-year yields between 2.75% and 3.25% in 2014, adds, To assume that yields will rise simply because the Fed stops its purchases is extremely Pavlovian. We just lived through a period when fixed income investors have been proven badly wrong on such an assumption. Real yields are a function of economic growth and activity as well as the pace of gains in employment. We shouldnt blindly assume that yields necessarily go higher.

Martin McGuire, managing director at TJM Institutional Services, is more bearish .

If we see 10-year yields move to 2.85% from [the end of October yield of] 2.62%, it suggests that a multi-month low will be in place, McGuire says. While we might not see a new low yield at all, we should not expect to see one until after the end of the first quar-ter of 2014 (see Is this the end? right).

McGuire says the hard sell off in fixed income and equities this spring could have been an upfront insurance policy paid for future volatility. He says it could have pro-

Tempering the taper

New energy world

For daily commodity updates, go to futuresmag.com

futuresmag.com 21

vided for lower levels of volatility as the Fed moved toward tapering, but unfortunately the Feds failure to pull the trigger on taper-ing may be a lost opportunity. By backing away from tapering in September, the Fed is back to square one. The market is once again wondering at every economic release what will be the implications for tapering, McGuire says, adding, I dont think the Fed intentionally misled. They got together at the meeting and they believed then and there that the risk to their credibility from misleading the market was not as great as the risk of moving too early and taking the accommodation away.

He expects 10-year yields to rise well above 3%, likely to 3.5% in 2014, and 30-year yields to move above 4% and approach 4.5%.

One of the reasons Wilkinson has been less bearish than many analysts on Treasuries is that he expects the Fed to hold onto its portfolio through expiration. It is pretty apparent that the Feds balance sheet is going to be left to wind down of its own accord over an extended time horizon, Wilkinson says. So the descriptions of the bond market that many are predicting simply [are] not going to happen. The Fed will not sell bonds and force yields up. That idea is so counterintui-tive that it makes no sense whatsoever.

More interesting could be movement in the yield curve. The 5-year/30-year yield curve is going to flatten like a pancake as the Fed moves through the tapering, McGuire says. If you believe the Fed has [the] intention to hold onto its portfolio, the policy rate will be required to do more of the heavy lifting. For any measure of eco-nomic growth (potentially inflationary), the Fed will need to raise policy rates more because it will not sell out the portfolio.

Equities continue higher?While there is consensus that equities are dependent on the pace of tapering, there is no consensus on what that pace will be.

Alan Bush, senior research analyst at ADM Investor Services, expects the equity bull market to continue its move upward, but not based on any organic strength, just on the tailwind the Fed is providing.

Equity indexes will continue to advance mainly because the Fed will taper later instead of sooner, Bush says, adding, The influence that will prompt the Fed to taper QE will be when inflation starts

to reemerge, which is likely to happen later rather than sooner. Until the Fed is fright-ened by inflation, they will not taper at all.

Anthony Lazzara, founder and principal of Lido Isle Advisors, is more bearish. The market is going to have to start pricing in a more hawkish environment, he says, adding, even if they dont taper, it will add volatility (see Wheres the vol? above). The market is going to be more proactive in pric-ing in taper. It is going to be an interesting year for financials; we have had all these

grinding up moves.Bush, however, sees equities trending

higher aided only by QE. The trend is still higher. Any bad news of any type will only have a temporary downside move. When they do taper, we will see a down move; I just dont think they will taper any time soon. In fact, if they do taper, whenever their tapering announcement is, they may have to delay the next [one] for the stock indexes to recover, he says.

Bush acknowledges that equities could

McGuire believes a move in 10-year yields above 2.85% could trigger a large advance in yields.

It seems strange that in a year with so much contentiousness, when there was a government shutdown and a threat of default, the so-called fear gauge wallowed at historic lows. This likely will change in 2014.

IS THIS THE END?

WHERES THE VOL?

Source: eSignal

Source: eSignal

3.100

3.000

2.900

2.800

2.700

2.600

2.500

2.400

2.300

2.200

2.100

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48.00

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26.00

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22.00

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2.763

12.67

10-year Treasury note yield

VIX (weekly)

2013 Feb Mar Apr May Jun Jul Aug Sep Oct Nov

Jul 2011 Jul 2012 Jul 2013 Jul


MARKETS continued

face a major downturn if he is wrong and the Fed tapers more aggressively. I dont think they will. Whatever the consensus view is on QE in [the] coming weeks and months, I will be farther out in terms of tapering expectations.

Both Bush and Lazzara expect greater volatility in currencies, although they take opposite views on the U.S. dollar. The cur-rencies will be very volatile with the dollar lower, Bush says. Lazzara sees a stronger dollar with the onset of tapering.

Although Wilkinson expects tapering to come, he says equities are ready to stand on their own. I find it very difficult to view equities negatively. They are not particularly costly. In the absence of an economic down-turn, I still think the trajectory on earning is constructive. So the bull market goes on, Wilkinson says, adding, The global econ-omy is set to recover more strongly in 2014 and that lends itself to firming demand for commodities, whose value has been falling even as the 2013 recovery expanded.

Natural gas in demand One of the more positive stories of 2013 was the speed at which U.S. energy production grew, which could make energies one of the more interesting sectors to watch in 2014.

We are in a new era of lower energy prices, declares Phil Flynn, senior ener-

gy analyst at The Price Futures Group. What is happening in the United States in terms of production is historic. It is game changing and it is changing the energy universe as we know it.

The shale gas and oil production in the United States is putting downward pres-sure on prices, which only may have been scratched in 2013 because of concerns over Middle East production.

It has been a choppy ride because of Hurricane Sandy and other [geopolitical] issues. But [with] the increase in oil pro-duction and the increase in capacity from many of our refiners, we are going to see prices go down, Flynn says. He notes that there is even the chance of cooperation with Iran. If they decide to play ball and allow inspectors in, they may come back [into] the global energy market.

Near term, he expects crude oil to test $88 a barrel, and if there is a mild winter, he believes it can test or even fall below $80.

Lazzara also believes crude will test $80. This sell off is just getting started, Lazzara says. There are a lot of players producing energy. Iraqs production is getting stronger.

Perhaps more interesting is the natural gas market.

Natural gas is almost like two differ-ent markets the long-term market and

the short-term market, Flynn says. The short-term market obviously is going to be dependent on weather. Right now nat-ural gas is under pressure. The long-term picture for nat gas 5-10 years we are near a historic low.

Flynn says just as high prices cure high prices, low prices cure low prices; as the shale revolution has brought down gas prices and eventually will bring down crude oil prices, low prices are creating increased demand particularly internationally for natural gas. There also has been a move by big transportation firms to move, ala T. Boone Pickens, to natural gas for fuel.

Fed Ex is changing all its short-duty trucks to natural gas. Warren Buffet is looking into running Burlington Northern [freight] on natural gas, Flynn says, noting the railroad is the biggest consumer of die-sel fuel after the U.S. Navy.

Meanwhile, Europe wants an alternative to its main natural gas supplier, Russia, which likes to bully its neighbors. And Japan has increased energy needs with reductions in its nuclear energy output. Russia is threatening the Ukraine, Japan is begging us to step it up, Flynn says. Japan and Europe want us to export natural gas. Natural gas last winter was going for as much as $20 in China.

Becoming a natural gas exporter will require the United States to ramp up liq-uefied natural gas (LNG) facilities, but with price differentials where they are, it should happen quickly. We were paying $3 or $4 over here. With that kind of dis-crepancy market forces wont let that con-tinue forever, Flynn says. If you ever get below $3 again, it is going to be a major long-term buy. Shorter term, it looks like $3.35. Over the next two years the demand for natural gas is going to explode, similar to oil prices in the late 1990s. What hap-pened is the demand for that cheap prod-uct exploded and then before you knew it we had a major bull market.

An interesting natural play may be its long-term price curve. The curve is rela-tively flat,which to me is amazing, Flynn says. If I were a big corporation and I could lock in September 2020 natural gas, I would be jumping all over it (see Hitting the curve, above).

The June 2017 natural gas contract at the

With increasing international demand turning natural gas into a global commodity, long-term prices may rise regardless of near-term fundamentals creating opportunities spreading the long-term price curve, which likely will steepen.

HITTING THE CURVE

Source: eSignal

7.6007.4007.2007.0006.8006.6006.4006.2006.0005.8005.6005.4005.2005.0004.8004.6004.4004.2004.0003.8003.6003.4003.559

3.9114.1024.2434.3574.4924.685

4.930

December 2020

December 2016

December 2018

December 2014

December 2019

December 2015

December 2017

December 2013

Sep Nov 2012 Mar May Jul Sep Nov 2013 Mar May Jul Sep Nov

Markets continued on page 44

futuresmag.com 23

TOP BROKERSBB continuedc d

a major growth contract area, while others noted the Vix contract as the rising star.

And although TradeStations CEO Sal Sredni sees growth for the firm in Asia and the Middle East, this is largely due to licensing the firms technology and not its brokerage business, which is mainly retail and U.S.-based.

Interestingly, merging the CFTC and Securities and Exchange Commission (SEC) had few proponents on our panel. Nessler noted that there would be more effective rule making if the agencies merged, but Escoffier notes that We do not believe a merger of the CFTC and SEC is critical with respect to the regulation of joint FCM/bro-ker dealers in the U.S. Indeed, while the U.S. is one of the few jurisdictions in the world that bi-furcates the regulation of futures and securities, there are numerous exam-ples of instances in which the same entity is governed by more than one regulator. Close cooperation in regard to the issuance of rules, examinations, enforcement and other matters between regulators that govern a particular entity is critical to optimize their efforts and mini-mize any unnecessary disruptions to the regulated entity. We also would like to see further harmonization of rule books to eliminate inconsistent, duplicative or overlapping regulations.

Many shrugged at the potential merger. Sredni said Be careful what you wish for, while Guinan noted that We cant know in advance exactly how this would play out. It would likely be quite a mess. We want efficient and good regulators. We dont necessar-ily need fewer regulators. A decade ago, New York State Attorney General Eliot Spitzer exposed the mutual fund timing scam that Wall Street firms were facilitating. The SEC completely missed this activity. The foxes have an ability to take over the chicken coops. Two regulators are better than one.

New trendsOn emerging trends, two reactions stand out. The first is many saw more consolidation of an industry that already is consoli-dating (see Divergence in the numbers, page 16). With the combination of increased costs in meeting new regulatory requirements and higher technology costs, we expect to see continued consolidation among FCMs, Gordon says.

Escoffier concurs: I expect to see further consolidation in the market. Regulation is making it harder for smaller FCMs to do business, and clients will gravitate to scale and proven expertise, i.e., the current top five players.

Corcoran believes the low-interest environment will continue, affecting FCMs in many ways. In the low-interest-rate environ-ment, in which there is slow growth in the industry and a high cost of compliance, we will see fewer firms able to survive, and therefore consolidation. We expect the low-interest-rate environ-ment to continue for the next two to three years, and smart FCMs

will have to address their pricing structures and models.Another focus would be continued regulation. Guinan says,

Greater regulatory costs will need to be passed on to clients in some manner. However, he also notes, As this rash of regula-tory over-reach subsides, the FCM industry can focus on expan-sion and the exchanges can turn their attention to creating new products rather than jousting in Washington.

TABBs Simon agrees that consolidation is definitely going to continue, but he says its harder for me these days to believe there will be a smaller number (of FCMs) as the number is starting to level off, he says (see Bigger firms getting bigger piece of pie, above). What he sees more likely is a large firm could leave the business, allowing other firms to grab market share. However, he does see business migrating to the biggest players with the big balance sheets, and that capital is power in the business.

Escoffier agrees, stating: Managing cash and collateral have become more important than ever with banks facing term liquidity shortages and pressure to diversify their sources of funding in the face of Basel III and CRD IV. Centrally cleared OTC markets also require higher initial margin and collateral capital. Hence, cash has become an asset class rather than a borrowing class pre-crisis.

In the end, many FCMs are optimistic. Guinan notes As the fixed income market descends, volume and return on investment of client funds should rise concomitantly benefitting the entire FCM community.

Gordon agrees, saying: Despite all that the FCM community has been through in the past couple of years, there is tremendous potential in the FCM model, and no one should underestimate our ability to innovate and reinvent ourselves as new challenges come our way.

are. Harketthe biggest players with the btee

capital is powapitstating: Mng:

portanorp rtrrtages s ag

he fackets al

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e endecommt funommon n thral in

y to y toyway.

After the 2008 financial crisis, the top five FCMs lost market share of customer accounts. That trend is changing, with the top five garnering an estimated 55% of the account balances.

BIGGER FIRMS GETTING BIGGER PIECE OF PIE

Source: CFTC, TABB Group

35%

23%

42%

34%

24%

42%

32%

25%

43%

28%

25%

47%

28%

26%

46%

19%

22%

59%

19%

24%

57%

21%

25%

54%

22%

24%

54%

23%

25%

52%

26%

25%

49%

15%

30%

55%

Percentage of account balances of top-tier FCMs, December 2003 December 2014

FCM business is controlled by bank, non-bank, and

futures only firms

Financial credit crisis prompts large move to

top 5 FCMs

Futurization and OTC clearing shifts business

to top 10 FCMs

Dec-03 Dec-04 Dec-05 Dec-06 Dec-07 Dec-08 Dec-09 Dec-10 Dec-11 Dec-12 Dec-13 Dec-14

FCM rank 15 FCM rank 510 Other

Top Brokers continued from page 17

Traders often seek repeated pat-terns or repetitive relationships that we can take advantage of for profit. These patterns exist across all markets and time frames, but some are more easily identified than others. One such exploitable pattern involves the Swiss franc and the U.S. dollar. This currency relationship typically repeats a certain move at least once a day during any given trading session.

The first step to understanding the relationship between the Swiss franc and the dollar is to examine the birth and evo-lution of the foreign currency. While it may seem unlikely that such ancient his-tory has any impact on the intraday fluc-tuations in the 21st century, it does help us appreciate the connections between the Swiss and U.S. denominations.

Prior to 1798, Switzerland as a coun-try was divided into cantons or provinces, each with its own currency. This is similar to the early history of America when the country operated under the Articles of Confederation and each state minted its own coin. Imagine how problematic that

was for conducting interstate commerce.In the Helvetic Republic, a late-18th

century effort to bring Switzerland under united rule, a currency pegged to the French franc was created. France was the premier world power at that time. Initially, this common currency was equivalent to 6.75 grams of pure silver or 1.5 French francs. This effort only lasted a few years, however, before local curren-cies regained favor.

A generation later, in 1850, the Swiss Federal Constitution mandated that only the federal government would be allowed to mint money, replacing the local currencies. Initially, the Swiss franc was pegged to the French currency and then directly to silver before Switzerland joined the Bretton Woods system in 1945, pegging its value to the dollar.

Fundamental driversToday, the Swiss franc sees signifi-cant f luctuations vs. other curren-cies. Throughout 2011, it had massive appreciation as the dollar slid. The stronger Swiss franc was not good for Switzerlands export economy, and the Swiss National Bank began targeting a value of 1.20 Swiss francs vs. one euro. The Swiss central bank would sell for-

eign currencies to achieve that rate. This is a common practice of central banks to keep their countrys products cheaper, and more attractive, overseas. Indeed, this is a cornerstone of Japans current so-called Abenomics principles.

In any case, the Swiss franc currently sells at or below the threshold of 1.20 euros. Most likely the reason for the mass appreciation was the Greek bail-outs that occurred during that time. Most Europeans were concerned that the euro would devalue, and the Swiss franc always has been the emblem of stability. Be warned, however, this is not to say that such a devaluation couldnt happen again. Its the type of major mar-ket-moving event that currency traders always should anticipate.

Today, each tick on a Swiss franc futures contract at the CME Group is worth $12.50. Unto itself, this is quite appealing, and better than other curren-cies such as the Canadian dollar or the Australian dollar.

In addition, the Swiss franc depicts behavior that repeats across trading sessions. This can be observed and rec-

Traders dont have to identify complex patterns to be successful. Simple reliable

relationships are all you need if you have the patience and discipline to exploit them.

Correlated opportunities in the Swiss francBY NICK MASTRANDREA

TRADING TECHNIQUES

C U R R E N C I E S


History lesson

How markets correlate

Anticipating intraday moves

For more from Nick, go to futuresmag.com/Mastrandrea

ognized after following the market on a day-to-day basis over an extended period. One such pattern is relatively simple a basic surge in either direction but alert traders can be prepared to take advantage of this surge when it happens. Here are the parameters of the move:t Once a day, typically in the morning,

the Swiss franc will make a move that is generally worth 20-30 ticks.t The move often is seen following a

major economic news announcement, in which case it may happen much later in the day. Case-in-point: On Sept. 18, the move didnt occur until after the 2 p.m. statement of the Federal Open Market Committee.t If no major news announcement is

planned, then generally the move will occur anytime after 10 a.m. (EST) once the markets have settled down post-opening and there is a better sense of direction.t This move corresponds to an opposite

move in the U.S. Dollar Index.t This post-10 a.m. move does not exclude

other moves throughout the day. Its identified here as a repetitive pattern that we can anticipate and exploit. Examples of recent moves in the December futures contract for both the Swiss franc and the dollar index can be seen in Up surge (right) and Order up (page 45).

Trading the moveThe charts reflect the inverse relationship between the Swiss franc and the U.S. dol-lar. Clearly there is negative correlation here a relationship that we would expect given the history of the Swiss franc and the fundamentals at work. The first step to taking advantage of this move is know-ing it exists. Then you can prepare for it. Each day, watch the dollar at or around 10 a.m. and look for direction. Typically, prices start to settle down a half-hour after the 9:30 a.m. open of the day session. This move usually breaks soon after.

Turn your attention to the greenback. When the dollar appears to be establish-ing a high or low near that time of day, look for opposite direction confirma-tion in the Swiss franc. For execution purposes, the Swiss franc offers the big-gest bang for the buck with a 25% larger

tick size. Among setup trades, this one is relatively safe and easy to spot, especially in the Swiss franc, which typically experi-ences extended moves when it does have a significant turn.

One method for getting into the mar-ket is to place a bracket order that will be executed in either direction at the time of the move. Consider a 10-tick stop and a 20-tick profit target. For most of these

moves, you can expect a 20- to 30-tick advance in either direction. Be prepared to modify the profit target if necessary.

Dont forget the stop loss, because any-thing can happen in a volatile currency market. A trailing stop is another layer of risk management. With a trailing stop, you enter with an initial stop loss then for each 10-tick move in your favor, the

futuresmag.com 25

On Sept. 18, the December Swiss franc contract didnt make its big move until after the FOMC statement (top chart). The December Dollar index futures had a corresponding move lower, falling hard and continuing lower through the session (bottom chart).

UP SURGE

Source: NinjaTrader LLC

1.0930

1.0925

1.0920

1.0915

1.0910

1.0905

1.0900

1.0895

1.0890

1.0885

1.0880

1.0875

1.0923

81.400

81.300

81.200

81.100

81.000

80.900

80.800

80.700

80.600

80.500

80.400

80.300

80.200

80.100

14:00 14:00 14:00 14:00 14:01 14:03 14:04 14:05 14:09 14:13 14:14 14:17 14:27 14:42

10:00 12:00 14:00 16:00

Trading Techniques: Mastrandrea continued on page 45

80.245

Here, we will illustrate the prof-itability of trading a currency position using strategies based on the Fractal Market Hypothesis as discussed by Edgar Peters and Benoit Mandelbrot. Well look at the fractal from the slant of a time series analysis provided by Mandelbrot in 1963.

Mandelbrot found that cotton prices (1900-1963) were not normally distrib-uted and instead showed clusters around the mean with a greater frequency of extreme variations (the tails) than that found in a normal distribution. This type of distribution is known as leptokurtic: A distribution that displays a positive value of excess kurtosis or sharpness of the peak of the graph of distribution. In other words, it has a higher peak than a normal curve and fat tails or higher density of values at the extreme end of the probability curve. Fat tails imply greater risk and suggest a nonlinear sto-chastic process. Assets that exhibit price jumps also display fat tail distributions.

Mandelbrots analysis led him to coin the term fractal, although he did not

provide a concise definition. Fractals are not limited to geometric patterns found in nature (some common fractals include seashells, snowflakes, ferns, coastlines and broccoli), but can also describe pro-cesses in time.

Fractals exhibit two quantifiable char-acteristics: Self-similarity and the fractal dimension. Self-similarity means that the parts are related to the whole. Peters puts it best: The object or the process is simi-lar at different scales, spatial or temporal, statistically. Each scale resembles other scales, but is not identical.

An object is said to be self-similar if it looks roughly the same on any scale. For this discussion, we assert that the trends found on a four-hour spot euro candlestick chart are fractal shapes: Each trend roughly resembles other trends, but they are never the same.

The fractal dimension measures how, in our particular case, a time series (a set of historical data) deviates. A line has dimension of 1, a plane has a dimension of 2, and a cube has a dimension of 3. A random line has a fractal dimension of 1.5. If a fractal dimension of a time series is greater than 1 but less than 1.5, then this particular time series exists between a straight line and a Gaussian random

walk. Again, Peters proposes an excellent definition: Regarding a time series, the fractal dimension measures how jagged the time series is.

We accept the fractal market hypothesis as stated by Peter and discussed below. Various empirical studies show that finan-cial assets produced skewed and fat tail return distributions (Mandelbrot, 1963; Fama, 1965; Hols, et al., 1991). In fact, the frequency distribution of currency returns has a higher peak and fatter tails than U.S. stocks or bonds. We define a short-term investment horizon as a period of less than five years and a long-term investment hori-zon of greater than four years.Portraying the market in five basic points: 1. The market is stable when it consists

of investors covering a large number of investment horizons. This ensures that there is ample liquidity for traders.

2. The information set is more related to market sentiment and technical factors in the short-term than in the longer-term. As investment horizons increase, longer-term fundamental information dominates. Thus, price changes may reflect information important only to

Traders are well aware of market-based fractal relationships spatial similarities that

can be captured across scales. All you need are the right tools.

Using fractals in forexBY LESLIE K . MCNEW

TRADING TECHNIQUES

C U R R E N C I E S


Capturing trends across time frames

How market periods are self-similar

Forex profits on short-term time frames

For more from Leslie, go to futuresmag.com/McNew

that investment horizon. 3. If an event occurs that makes the valid-

ity of fundamental information ques-tionable, long-term investors either stop participating in the market or begin trading based on short-term information. When the overall invest-ment horizon of the market shrinks to a uniform level, the market becomes unstable. There are no long-term inves-tors to stabilize the market by offering liquidity to short-term traders.

4. Prices reflect a combination of short-term technical trading and long-term fundamental valuation. Thus, short-term price changes are likely to be more volatile or noisier than long-term trades. The underlying trend in the market reflects changes in the fundamental (economic) environment. There is no reason to believe that the length of short-term trends is related to the long-term economic trend.

5. If a security has no tie to the economic cycle, then there will be no long-term trend. Trading, liquidity and short-term information will dominate.

Setting up the tradeHere are the basic facts of our trade sce-nario:t Book balance $10,000t Position size 10,000t Instrument: Spot . No transactions

fees are paid when trading spot forex.t Backtested data: Spot four-hour data

(Jan. 1, 2007 to June 30, 2013). Data provided from www.fxcm.com t Trading periods: Execute only on four-

hour candlestick window. Testing on data with 1 a.m., 5 a.m., 9 a.m., 1 p.m., 5 p.m. and 9 p.m. candlestick windows. The importance of the timing of the four-hour candlestick is stressed. Monthly U.S. economic information is released at 8:30 a.m. and 10 a.m. It is important to note that the model transaction will occur after/before possible periods of market stress (like on the release of the monthly employment data).t Book leverage: Approximately 1.30t Trend indicator: Exponential moving

averages (EMA). Fast EMA: 10-period (10 periods of four-hour blocks of data). Slow EMA: 20. This pair was

backtested as optimal for this currency and this time interval.t Transaction times: At the open of each

four-hour candlestick. No other trans-actions are allowedt Transaction limit: 40 pips per 10,000

position; each pip is worth $1t Transaction stop: 20 pips

We have examined a set of trades that are low risk, provide consistent low returns with a leverage of less than 1.5 and can be automated, which ensures low human cap-ital fees. We consider this group of trades the annuity trade of the portfolio, or the first step of a return pyramid for a specula-tive portfolio. In terms of a baseball meta-phor, this model is the first base of firm profit and not a home-run trade.

As the model operates in the short-term, we use technical indicators, partic-ularly EMAs, to indicate the possibility

of a trend. This is our only attempt to create some logic out of the noise that is produced at the short end of the market. It has been shown that short-term inves-tors rely heavily on technical indicators.

Think of the greed and fear patterns (the positive and negative price movements) of the four-hour candlestick chart as a countrys coastline. Determining the length of a coun-trys coastline is not as simple as it appears, as first considered by L. F. Richardson (1881-1953) and sometimes known as the Richardson effect (Mandelbrot, 1983). In fact, the answer depends on the length of the ruler you use for the measurements. A shorter ruler measures more of the sinuosity of bays and inlets than a larger one, so the estimated length continues to increase as the ruler length decreases.

Traders do not know the optimal ruler to use to catch the maximum amount of profit for each inlet of price

futuresmag.com 29

We do not take a position if the EMAs cross during a four-hour window. The position is only entered at the open of the next bar.

ORDER OF ANALYSIS

1.2950

1.2900

1.2850

1.29271

3) Limit order hit 40-pip profit

2) Enter into long position with limit order and stop loss at open of NEXT candlestick

1) EMA Cross during 4- hour (No Action). Dotted green line demonstrates EMA cross

On some candlesticks, we cant be sure if the profit limit or stop loss was hit first.

WHICH CAME FIRST?

movement (trend). Our ruler is the limit order and our inlets are the trends of the four-hour market as depicted by the 10- and 20-period EMAs. Each inlet has two legs: The long trend (10 EMA > 20 EMA) and the short trend (20 EMA > 10 EMA). Because the optimal limit order is not known and the frequency and magnitude of each inlet are not consistent, we aim for profitability by taking a small bite out of each leg of each market wave.

The optimal EMA period lengths, limit orders and stop order amounts for the trading model were determined through backtesting using data from 2007 to June 2013 (four-hour data from www.fxcm.com). Regarding limit orders and stop orders, we looked for a combination that supplied con-

sistent profits with low risk levels. Our back-testing return analysis for this model is found in Cumulative results (above). All returns are produced using CFA-recommended methodology: Geometrically linked returns.

Regarding the use of leverage in this model, the mean hedge fund industry leverage is approximately 2.13 with a standard deviation of 0.616. Hence, we sought to construct a model that tar-geted this industry average.

Trade mechanicsA transaction only will be considered at the open of each four-hour window and, if necessary, executed. This means that there are six four-hour candlestick windows in a daily 24-hour period and,

thus, there are only six possible periods of transaction.

To open a trade, evaluation of the pair of EMAs occurs. If 10 EMA > 20 EMA, then a long position is taken. If 20 EMA > 10 EMA, then a short position is taken. At the time of trade entrance, both limit and stop orders are placed 40 and 20 pips away from the entry price, respectively. The transaction is automatically exited when the limit or stop order is hit. Our currency platform is FXCM and these orders are executed with little slippage except in the rare instances of complete market chaos.

There is no transaction on the anticipa-tion of an EMA pair cross. The EMA signal must be firmly in place for trade entrance (see Order of analysis, page 29). Because of this, the model is considered a lagging one. The trade entry only occurs firmly after the EMA signal and only at the time of the open of the four-hour candlestick window. The exit of the trade occurs on a pre-set limit or stop-order basis, or change in trend direction.

The model would be more profitable if the transaction took place as close to the actual EMA cross as possible, without the imposed time lag of execution only at the four-hour window. However, our available dataset for backtesting limited us to the use of the four-hour candlestick for trade entrance.

The ambiguity issueThis model was designed to trade on and was historically optimized using four-hour EUR/USD candlestick data. We have found that backtesting the model produced, on some occasions, an ambiguity issue: It is impossible to tell in a transaction which was hit first in the candlestick data the limit or the stop. In other words, if the candlestick price depth is such that both the limit and the stock were met inside the pricing period, it may not be certain which order was executed first.

But the ambiguity issue does not sig-nificantly alter the return profile of the model. For example, in 2007-2013 there were approximately 10,000 model entries and the question of ambiguity arose approximately 50 times. The spread-sheet screenshot in Which came first? (page 29) illustrates the small possibility

TRADING TECHNIQUES continued


Here we can see a quick comparison of the three methods of determining whether the stop or limit was hit on the few instances the candlesticks were large enough to capture both.

Our basic model provides consistent returns over time in the euro.

METHOD COMPARISON

CUMULATIVE RESULTS

Candlestick method Optimistic method Conservative method

Year Cumulative returns

2007

Futures Dec 2013

Documents

Transcript of Futures Dec 2013