Asset management, Commodity price, Commodity risk, Hedging, Risk management, trend following

Lessons in trend following: how we traded sugar

Sugar prices have soared on the CSCE (Coffee, Sugar and Cocoa exchange) from just over $0.10 per pound in August 2015 to over $0.23 at present – a fairly sharp jump by any standard, particularly after several years of continuously falling prices. I trade sugar using our trend-following model and to channel my inner Donald Trump – we’ve done tremendously well, generating a respectable grosss annualized return of nearly 10% per annum over a 5-year period. Now, the main reason I find this remarkable is that I know next to nothing about the fundamental economics of the sugar market. I know it goes into biscuits and beverages, that it comes from sugar cane or sugar beets, but that’s about it.

The only reason we’ve been able to trade sugar profitably is that we use a trend following model and believe that significant price readjustments almost always unfold as trends. So far, markets have not proven us wrong. Below is a chart of our trading performance on sugar together with a few lessons for aspiring commodity traders and trend-followers. The chart shows the price of sugar from November 2011 (our inception of trading) and the gross trading performance of the 19 trading strategies we’ve used over the period:


As the chart shows the strategies have performed moderately well, but not without some difficulties, particularly through 2013 and 2014. In fact, what stands out is that they have not performed so well until mid-2014 even though a strong and clear down-trend spanned nearly four years’ period through August 2015.

Unfortunately, the nature of this trend was unusual in the context of historical fluctuation dynamics of the sugar markets: sugar’s downtrend started with a sharp reversal in the beginning of 2011. Then, through 2012, 2013 and 2014 it is interspersed with deep, sharp corrections, several of which were interpreted as trend reversals by most of our strategies. As a result, instead of staying on the short side of the trade throughout the four year period, they switched from short to long several times, essentially treading water. The following chart shows the above period in context of the past ten years’ price history:


The chart makes it quite apparent that price fluctuation dynamics changed starting from 2005 – a phenomenon that occurred in most if not all commodity markets as the following chart shows:


The new, more turbulent environment has become more difficult to navigate for trading strategies formulated over the long-term price history . At this point, many people ask why not adjust the strategies to the new trading environment when changes are this obvious? At first blush, this seems like a good idea. However, falling into the temptation to formulate trading strategies only over the most recent price history  is asking for trouble. Instead of optimizing performance over the recent history, the systematic trend follower ought to seek out strategies capable of performing reasonably in all environments. Such strategies will be more robust and will sustain performance more reliably in the future.

The way we seek to adapt to the changing dynamics in commodity markets is by continuously refreshing the “genetic pool” of our strategies with new ones, always formulated over the entirety of the available price history spanning a minimum of 20 to 30 years. Our NYCE Sugar trading strategies – among others – are beginning to prove us right. In spite of getting sea-sawed for a few years, they have generated positive performance over the period, reaching an average gross return of 56% since inception (measured against the relatively generous risk budget of $12,500 per contract traded). This represents a respectable 9.64% annualized gross return in a difficult and challenging environment.

Alex Krainer is an author and hedge fund manager based in Monaco. Recently he has published the book “Mastering Uncertainty in Commodities Trading“.


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