SECRETS TO SUCCESSFUL INVESTING“The advisor has such a great record, but since I opened an account one year ago, I am down 20%. This ad-visor is never going to make money; I’m closing my account.”

Sound familiar? Is it wise to judge a Commodity Trading Advisor (CTA) on the basis of only a few months or even one year of flat performance if the CTA with whom you have an account has demonstrated prior above-average returns for three years or more? We strongly believe the answer should be a resounding no!

Over the years, we have reviewed the performance records of a multitude of CTAs. After observing many mil-lions of dollars made and lost, we have come to this conclusion: We believe that many people who are unsuc-cessful in futures could improve their results by changing not only the way they make investment decisions but also their time-frame perspective in futures investments.

Being a successful futures investor isn’t easy. It sometimes seems an uphill fight, battling your emotions just to be able to cope with drawdowns and those non-productive periods in the life of your account.

Unfortunately, drawdowns are an inescapable part of futures trading. For the unsophisticated, uninformed, or overly sensitive investor, drawdowns can be the “gremlin” that inflicts such emotional distress that one’s patience is worn to the breaking point. The result: The investor “throws in the towel,” often suffering losses which might have been reversed and possibly turned into profits with just a bit more patience. Needless to say, a number of stock and futures investors who experienced drawdowns and “threw in the towel,” only to suffer losses, probably missed the boat.

This point is exemplified by a comment made by Peter Lynch, the highly-respected former manager of Fidel-ity’s Magellan Fund. Under Mr. Lynch, the Magellan Fund grew to be one of the most successful funds ever. However, Mr. Lynch related that he believed as much as 50% of the fund’s investors lost money. How could this be possible?

The answer is offered in a comment made by the manager of the Z Seven Fund:

“I have noticed with my own portfolio management business that most clients are eager to start at a market top based upon recent excellent performance and many are quickly shaken out at the next bottom, feeling disillusioned and even hopeless. Few investors will hold patiently through market cycles. Even fewer will add to their investment when it is a bargain. The battle won by the successful investor is a battle with the one who is potentially his worst enemy: Himself! To win this struggle against greed, fear, complacency, disillusionment, anger, and ego, one must be insulated from outside influences (the media, friends, family, etc.) and stick steadfastly to a sensible, predetermined game plan. In a word: DISCIPLINE.” We believe this concept also applies when investing in managed futures.

It may be human nature to want immediate gratification and profits without experiencing drawdowns or any losing trades; but in the long run, this is fantasy, not the real world of commodity or stock investing. The best traders, in both futures and stocks, exhibit periods of flat to poor performance. Realistically, losses as well as profits are an integral part of all track records!

OVERCOMING YOUR EMOTIONS

The biggest problem, as we see it, is overcoming one’s emotions--frustration and lack of patience--even with top performing CTAs during their inevitable drawdowns and flat performance periods. It’s not easy to go against human nature. It’s a natural reaction to be frustrated and impatient with losses or flat performance. But that’s why, as can be inferred by Peter Lynch’s previously described experience with the Magellan Fund, many investors wind up losing, even with top performing investments.

When investing with a CTA, we believe one can overcome the anxiety associated with drawdowns and stag-nant performance periods, and improve his or her chances of being successful, by thinking with the head and not the heart. Unfortunately, from what we have observed, many investors make their investment decisions for all the wrong reasons: emotional gut feelings, hopes, wishes, dreams, and the opinions of others to name a few. We believe being swayed by these factors just perpetuates investors’ bad luck and makes losses a self-fulfilling prophecy. Instead, we recommend a realistic understanding of the inevitability of drawdowns and flat performance periods coupled with an INVESTMENT GAME PLAN based on what we term Reasonable Confidence.

SELECTING A CTA

In our opinion, the most important (and logical) criteria for selecting a CTA should relate to the actual track record of performance of the CTA, not the “emotional feelings” for a CTA exhibited by the investor, his friends, or relatives.

We feel an investor should place his trust in a CTA that has a record of positive performance. Selecting a CTA can be compared to choosing an employee. An employer probably wouldn’t rely so much on what the pro-spective employee tells him but what his resume or track record documents. When scrutinizing a CTA’s per-formance record, look for the following key ingredients:

1. A minimum of one million dollars under management. 2. Drawdowns held under 50% over the entire performance record. This means a $100,000 investment drop-

ping no further than $50,000. 3. Recovery from all drawdowns with respective new highs achieved in equity within an 18-month period. 4. An average return of at least 15% per year after all fees and commissions based on a cumulative three-

year period.

Please be advised when selecting a CTA that past performance is not necessarily indicative of future results. There is a substantial risk of loss in trading futures and options and such trading is not suitable for all inves-tors.

REASONABLE CONFIDENCE

Wouldn’t an investor feel more comfortable during a losing period if he or she knew that over any 18-month period a CTA never suffered losses so large that the CTA didn’t subsequently recover and make new highs in equity while averaging at least 15% per year for at least a three-year period?

Moreover, wouldn’t the investor feel even more comfortable if he knew the drawdowns he was currently ex-

periencing were in line with the historical drawdowns evidenced in the performance record which was subse-quently erased by profitable returns? Investors should be aware that there is a possibility that the CTA will not always recover from a drawdown.

This is the foundation and reason for having what we call “Reasonable Confidence.” Reasonable Confi-dence in a CTA should provide the inner fortitude to weather the inevitable drawdown periods that all CTAs experience. We believe if you don’t have “Reasonable Confidence” in a CTA, you shouldn’t invest with that money manager!

THE INVESTMENT GAME PLAN

Once a CTA is selected based on Reasonable Confidence, the investor is now ready to develop an INVEST-MENT GAME PLAN for investing with the CTA.

We believe the Investment Game Plan should consist of the following:

1. Most importantly, only risk capital should be utilized. Risk capital is defined as those funds which, if you lost them, would not affect your lifestyle. Funds marked for a down payment on a house, a child’s educa-tion, or core retirement funds should not be used.

2. Envision a drawdown cutoff point of 50%. Close the managed account only if that level is reached. If an in-vestor isn’t prepared to adhere to this guideline, we believe he is not suitable for a managed account. The 50% cutoff may not limit the loss to the amount intended. Certain market conditions may make it difficult or impossible to close out the account with only a 50% loss.

3. Have realistic expectations. The average performance for the Dow over approximately the past century has been around 10%. A CTA who can provide you average annual returns above 15% per year over a three-year period is substantially outperforming the Dow’s average. However, that CTA has an ever pres-ent risk that he or she could potentially lose all of your investment and you would be called upon to make up any deficiency.

4. Accept drawdowns and flat performance periods as inescapable parts of speculation in futures. 5. As long as predetermined cutoff points aren’t reached, stay with the CTA through “thick and thin.” 6. Look at the big picture, not the meaningless episodes. Evaluate performance over a three-year average

(big picture) not week to week or month to month (meaningless episodes).

Now that a CTA or group of CTAs has been chosen by the investor, not on emotion but rather on Reasonable Confidence with a specific INVESTMENT GAME PLAN, he should be psychologically prepared to weather the losses that are inherent in commodity investments.

THE INVESTOR PACT

We believe the proper attitude should be: “Potential risk of loss is the price I must pay for opportunity. I don’t want to lose, but the capital I have invested is risk capital that I don’t need to live on and wouldn’t in any way change my style of living if I did lose. I understand that the past is not an indicator of the future. Even so, I believe that over time my investment should do well because the CTA I have chosen has an excellent perfor-mance record, and has demonstrated recovery from every drawdown to achieve new highs in equity! Being human, I realize that my CTA will have losing as well as winning trades. This is part of futures trading. I will not lose confidence or fall prey to my emotions during drawdown periods. I will stay tough and hang in there!

I will have patience and, as long as my account doesn’t fall below 50% of my initial investment, I will give the CTA three years to perform.”

IN CONCLUSION

We don’t profess to be an oracle on futures investing; but, from our years of experience, we are firmly convinced the beliefs and suggestions we have presented in this report can alleviate the anxiety, second guessing, and loss of confidence associated with drawdown periods. Following the suggestions in this report will by no means assure an investor’s success in a managed account but, in our opinion, will increase the probability of success!

We hope we have been informative and wish you the best of luck in your investment endeavors!

Please be advised that trading futures and options involves substantial risk of loss and is not suitable for all investors. Past performance is not necessarily indicative of future results.