A few of Wall Street’s favorite catch phrases need to be defined:
CTA: CTA stands for commodity trading advisor. It is a government term used to classify regulated fund managers who primarily trade futures markets. Almost all successful CTAs trade as trend following traders. CTAs are the other quants the media never seems to cover accurately.
Managed Futures: This is a term that describes regulated fund managers who use futures to trade for clients. It is an awful term because it fixates on the instrument (futures), not the strategy. Here’s the dirty little secret: Almost all successful managed futures trading firms use a trend following strategy. The term is often used interchangeably with CTA. Noted radio host and author Dave Ramsey recently had this to say about managed futures: “The term managed futures is virtually an oxymoron…with managed futures you’re basically betting on the future price of a commodity. What’s the price of gold, or oil, or wheat going to be somewhere down the road? You’re guessing as to what the future will bring, and managing a group of those guesses. What a joke!” If you share Dave Ramsey’s view and understanding, I recommend a full frontal lobotomy as your best wealth-building plan.
High Frequency Trading: High frequency trading is the latest term to describe arbitrage— at whatever time frame. It is about getting an advantage through speed and access. Most people are not going to enter the world of high frequency trading (or be Goldman Sachs). It’s a nonissue for your trading success.
Global Macro or Systematic Global Macro: Global macro is another term used to describe trend following traders, but indirectly. They do not say managed futures, and they do not say hedge fund, so it is global macro. It might make wealthy investors in Liechtenstein and Saudi Arabia feel more secure. The strategy is still trend following.
Hedge Fund: Think unregulated mutual fund that can trade in all markets up and down. Most hedge funds have terrible strategy: They are long only on leveraged stocks. That’s it. Not as sexy as the press makes it. Of course, it all depends, and some hedge funds do make a killing. Usually, they are of the systematic trend following variety.
Long Only: Long only means you make one bet. You bet that the market will always go up.
Buy and Hold: Buy and hold (hope) is the same as long only.
Index Investing: You buy the S&P 500 Index and whatever it does is the return you get.
Value Investing: Attempts to use fundamentals to uncover undervalued stocks. The belief is you are buying cheap or low (terms that can mean anything to anyone). When that doesn’t work out, you call the government and ask for a bailout.
Quant: You use formulas and rules, not daily discretion or fundamentals to make trading decisions. That said, unless quant is defined with precision you can never know what it means exactly. Trend following is a form of quant trading.
Repeatable Alpha: Alpha is return generated from trading skill. If you buy and hold the S&P 500 Index, and if it makes a positive return, that’s not alpha. That return is beta for there was no skill involved. Repeatable alpha is simply the nice academic way of saying profit from skill. Trend following’s argument as the only repeatable alpha is tough to counter.
Beta: The return you get for accepting the average. There is no skill involved. Think about a monkey aimlessly throwing darts against the wall— it’s that level of skill. Long: You buy a stock or futures contract.
Excerpted from Trend Commandments.