CTA Trading Strategy

Learn the secret behind the CTA trading strategy using quantitative trading models to generate buy and sell signals. Throughout this guide, we’re going to explore the profit potential of the CTA strategy. More, we’re going to outline how CTA trading works and how you can enhance your trading with the oldest trend-following systems on Wall Street.

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According to BarclayHedge, one of the most respected research-based providers, the CTA commodity trading space has experienced rapid growth of $318 billion in assets under management.

If the interest in the alternative investment vehicles is at an all-time high it means there are investment opportunities in the CTA space. One way to benefit from this unique trading opportunity is to study what types of CTA trading strategies the money managers use.

Not many know, but the CTA fund strategy is almost synonymous with the trend following strategy.

If that’s the case, we’re going to reveal the secrets behind the trend-following CTA trade signals so you can take advantage of both rising and falling prices.

But, let’s start with a quick overview of what is CTA in finance and how the CTA futures trading work.

See below:

What is CTA Trading?

CTA trading strategy

In finance, CTA is an abbreviation for Commodity Trading Advisor.

A CTA is a professional money manager or a hedge fund that trades futures contracts, commodities, options, and certain foreign exchange instruments in more than 150 global markets.

Learn more about other tricks used by CTAs here: Hedge Fund Strategies and Tools Used on Wall Street.

Basically, in CTA finance, a commodity trading advisor tends to run managed futures strategies with OPM (other people’s money). As you might think in the US, managed futures are regulated by the Commodity Futures Trading Commission (CFTC) and the National Futures Association (NFA) so you can be sure the CTA fund strategy use strict risk management rules.

Now, you might be wondering, what are managed futures?

Note* Trading futures and options involve a high risk of losing your investment.

In layman terms, managed futures are a type of unconventional investment approach in which the portfolio is actively managed by professional money managers like CTAs. This also explains what is a CTA fund.

CTA trading looks for ways to make money in both up and down markets. So in order to accomplish this, they will implement a multitude of CTA futures trading strategies.

Moving on…

We’re going to share the most popular types of CTA commodity trading strategies.

See below:

Types of CTA Trading Strategies

cta trading

Institutional traders have several CTA trading strategies that can use to thrive in any type of market environment. The two of the most popular CTA investment strategies that can be used by a CTA fund are:

  • Systematic strategies
  • Discretionary strategies

These two leading strategies used by the CTA investment funds are largely available to be used by the small investor as well. The difference between systematic and discretionary trading is the following:

Note* There are also CTA commodity trading strategies that focus on niche trading plays like market-neutral strategies or delta-neutral strategies.

Now, our team of experts at Trading Strategy Guides will focus on CTA systematic strategies.

Why?

Well, it’s because when we remove the emotional element from the equation of trading we improve our odds of success. Now of course, if you have a gut feeling that comes from tens of years of trading experience, you can override the trade signals of your CTA strategy at your discretion.

No CTA investment strategy is foolproof.

Moving on…

Let’s stop for a little bit and see how the typical hedge fund algorithm works.

See below:

How does CTA Trading Strategy work?

CTA strategy

The mechanisms behind the CTA trading strategy are similar to any other trading strategy.

You’ll be surprised to learn that most CTA strategies are based on simple stuff like moving averages, momentum indicators or pattern recognition. They are mostly CTA technical analysis based strategies.

However, we can distinguish at least two differences.

First…

The main ingredient of a CTA investment strategy is contingent on the ability to construct a diversified portfolio. That’s investing in several global markets and trying to capture both bullish and bearish trends.

Second…

The CTA trading models rely heavily on analyzing a huge amount of price data that encompasses even 100 years' worth of data.

These two elements are what make the CTA strategy so much more reliable when it comes to correctly predict the direction of the trend and being profitable. Not all trends are created equal, so by diversifying their portfolios, CTA managers can increase their chance of actually capturing a really big trend.

Moving on…

Our team of experts will outline a CTA trading algorithm that can be used without the need of having fancy financial models. You can trade this CTA strategy from any trading platform that offers charting packages.

See below:

CTA Trading Strategy

In this section, we’re going to provide you with a framework to build a trend following model based on price action. We’re also going to provide you with some of the foundations of how the CTA trading strategy works.

When you go through the process of building a trend-following model, it’s important to first have a strong foundation. But, the reality is that most trend-following rules attempt to achieve the same results i.e. capturing the trend.

Once you grasp that no matter how much you twist the trend following system rules, in the grand scheme, it doesn’t affect the outcome of your trading activities. As we mentioned earlier, the value of the CTA trend trading system comes from diversification.

Now, don’t worry if you don’t know any decent trend following system.

We’re going to share with you some CTA trading rules that will help you achieve the same results as the top CTA fund managers.

Are you ready?

Then, let’s get started.

CTA Trend Filter Rules

The trading rules are the least important thing with trend-based systems, however, to maximize gains it’s important to be able to detect trends as early as possible.

In this regard, we’re going to reveal two of the most important moving averages used on Wall Street since the early 1900s. The 50-day moving average in combination with the 100-day moving average is our primary tool to gauge the trend direction.

Here are the rules to determine the uptrends and downtrends:

  • We’re in an uptrend if the 50-day moving average is above the 100-day moving average.
  • We’re in a downtrend if the 50-day moving average is below the 100-day moving average.

CTA trading

These trend filter rules are quite simple, nothing complicated here.

The trend-following rules are designed to keep you with the dominant trend and to reduce the risk of getting whipsawed by the price action.

Now, you might be wondering…

How do I decide to enter the trend?

See below:

CTA Trading Rules for Entries

There are many CTA technical analysis tools that can be used to trigger your entry. However, make no mistake, no matter how much you want to improve on your trade entry, in the long run, it doesn’t matter.

In the context of a trend market timing is secondary to things like position sizing.

So, to keep things simple…

We enter a long position when we break and close above the 100-day moving average.

And, vice versa, we enter a short position when we break and close below the 100-day moving average.

CTA strategy

Don’t be a novice trader and focus all your energy on your entries. But, instead, try to analyze how to diversify your holdings and how much to risk on each trade.

This brings us to the next point.

See below:

CTA Trading Diversification

Here is the thing…

Some trends are stronger than others. Inherently, some stocks can develop stronger trends than others. Secondly, there may be long periods, where the market is flat and no trend is presented. In some instances, when we don’t have a catalyst for trend development, the market can stay trendless for years.

CTA strategy

At the same time, when the market is not trading we can also have lots of false signals.

Now, the key idea is to cover more than just one market and built up a portfolio of trades, the same as in our latest forex basket trading strategy.

When you try to catch trends from multiple instruments at the same time you increase your odds of success.

Let me explain…

Trends come in different forms and shapes.

Some trends will last for a very short period of time. Other market trends will reverse on you, right when you enter the market.

The idea is that you will incur losses.

It’s inevitable.

But, with diversification, it will allow you to catch a big trend as well.

No one knows what market trends will continue to develop and what market trends are doomed to die unless of course, you have the Holy Grail. So, by diversifying in multiple trends you can take small hits her and there, but if one market emerges with a strong trend you can overcome all your losses and finish the line with a lot of profits.

See the trend trades example below:

CTA risk management

cta risk management

cta trend following

Just for simplicity, we’re going to assume we’ve bought the above three stocks Apple, Facebook, and Twitter. All of the three stocks started to emerge into an uptrend, more or less, around the same time.

What is the first thing that pops up though your mind studying the 3 stock charts?

The trends developed on the Twitter and Facebook chart price were short-lived.

So, he took a hit on those two trades.

However, with our Apple trade, we were able to recover all of our losses and make a nice profit.

That’s the power of CTA diversification in action.

Now, what if we told you that the CTA fund managers use position sizing in their favor to further turn the odds of success.

What do we mean by that?

CTA trend following strategies also uses volatility-based position sizing. The trading principles are simple, allocating different position sizes based on the level of stock volatility:

  • Take larger position sizes for less volatile stocks.
  • Take bigger position sizes for higher volatile stocks.

With this approach theoretically, each trade should have the same impact. Most CTA funds use the Average True Range (ATR) as a proxy measurement of volatility.

Final Words – CTA Strategy

In summary, CTA trading offers an exciting opportunity for both long and short investors. With the CTA trading strategy, you can achieve a true diversification of your portfolio by spreading the risk across several positions.

However, you have to keep in mind that generating positive returns are dependent on your skills to identify good trading signals. Outstanding returns can’t be achieved only through diversification.

So, here is a short recap of the CTA strategy:

  • A systematic approach is superior to a discretionary approach.
  • Define the uptrend and downtrend combining the 50-day MA and 100-day MA.
  • Diversify your portfolio with multiple positions.
  • Use volatility-based position sizing to maximize your profits.

Thank you for reading!

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With over 50+ years of combined trading experience, Trading Strategy Guides offers trading guides and resources to educate traders in all walks of life and motivations. We specialize in teaching traders of all skill levels how to trade stocks, options, forex, cryptocurrencies, commodities, and more. We provide content for over 100,000+ active followers and over 2,500+ members. Our mission is to address the lack of good information for market traders and to simplify trading education by giving readers a detailed plan with step-by-step rules to follow. 

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