Cover Story: The mind of a futures trader

This article first appeared in Personal Wealth, The Edge Malaysia Weekly, on November 12, 2018 - November 18, 2018.

(Left) Discipline is the main criteria of successful trading. You have to know how to make it part of your character - Ang. (Right) Our experience makes us more prudent and it has trained us to focus more on risk management - Tan. Haris Hassan/The Edge

-A +A

Growing up in families with non-financial backgrounds has not stopped Tan Ken Tak and Ang Yue Een, both 34, from making their mark in the local investment industry. Today, they are fund managers of the Phillip Global Futures Fund, which has generated a return of 14.28% (as at Sept 30) since its inception in July last year.

Both of them came from modest beginnings. Tan’s father was a factory manager and his mother worked as a clerk at a rubber factory. Ang’s dad ran a coffee shop while his mom was a homemaker.

After graduating from Universiti Tunku Abdul Rahman with degrees in business administration and accounting respectively, Tan and Ang joined CIMB Futures Sdn Bhd as brokers within three years of each other.

Tan went into the industry by accident. “I became a fan of Warren Buffett’s value investing strategy when I was in university. I read up on stocks, but did not know anything about futures,” he says.

“One day, my dad saw an advertisement in the Chinese newspaper that CIMB was looking for a trading assistant and suggested that I give it a go. He thought I would be trading in the stock market.

“When he learnt that I was joining the futures industry, he got worried and was opposed to the idea. He had experienced the 1997/98 Asian financial crisis [which was partly triggered by short-selling] and seen many people get burnt and go bankrupt. In Hong Kong, some people jumped off buildings after they lost all of their money.”

Tan joined CIMB Futures in 2006 and asked Ang to come on board in 2009. They quickly learnt the ropes and in 2011, they decided to venture out on their own by registering as local participants of Bursa Malaysia Derivatives Bhd. This marked the start of their journey as full-time, independent futures traders.

“It was stressful at the beginning. I dipped into my savings and we borrowed from our families and friends. We managed to raise about RM150,000 each. That was all we had to trade with. If we had lost the money, it would have been very challenging for us to start over,” says Tan.

“We treated trading like a business and the money was our initial capital. If we had lost it, the business would have failed,” says Ang.

However, the decision to venture out on their own turned out to be the right one. Tan was profitable every year from 2011 to 2016 while Ang only saw a loss in 2013.

At first, they traded locally listed derivatives such as the FTSE Bursa Malaysia KLCI Futures (FKLI) and Crude Palm Oil Futures (FCPO). Later, from 2012 to 2016, they traded futures contracts in overseas markets such as the US and China.

What were their returns like? Tan says they ranged from 100% to 300% a year. “We regularly took profit each year and did not reinvest the money. The main reason was there was not enough depth in the local futures market. Based on our trading strategies at the time, we found it hard to manage trades if we constantly reinvested our profit.”

Andy Lim, CEO of Phillip Mutual Bhd, was a friend of Raphael Kok, the duo’s superior and mentor at CIMB Futures. While Lim knew Tan and Ang back then, they captured his attention when they were trading full-time on Phillip Futures’ online platform. Impressed with their trading record, he asked them to launch a futures fund under Phillip Capital Management Sdn Bhd .

“We had been trying to launch a futures fund and tested out a few [trading] strategies internally. These attempts were unsuccessful even at the paper trading stage,” says Lim.

“So, I thought, ‘Why not invite them to start a futures fund with us?’ First, they had a good track record. Second, it would be the first of its kind in the market and would provide investors with more choices.”

He adds that the duo were the right fit for the futures fund because they were more ambitious and flexible than the other traders. “They were mainly trading FCPO and FKLI, but were willing to venture into overseas markets and try out various trading strategies.”

Lim says this was important because a futures unit trust fund that catered to individual investors would need proper diversification measures in place to avoid huge losses at any point in time. The fund manager would have to diversify investors’ money into overseas markets even though this could pose a challenge. They would also need to adopt different trading strategies and adhere to a new set of rules. They would not be able to trade as freely as they had been.”

 

‘You learn the most from losing trades’

However, the journey has not been plain sailing. There were times when both suffered huge losses and even went broke.

“These are the things that a professional trader has to go through. You learn the most from these losing trades where get you burnt. They taught us important lessons on how we should manage risk, stay disciplined and not be overconfident,” says Tan.

One such experience was in 2011, when Tan was still working at CIMB Futures. He and his team had made a bet that CPO prices would fall by year-end. “It was a seasonal thing and CPO prices would fall [due to higher crop production]. So, we recommended that clients use the calendar spread trading strategy,” he says.

“What we did was we shorted the near-month contracts [which would expire in the next two to three months] and went long on the far-month contracts [which would expire in the next six to seven months]. We anticipated that the CPO price of the near-month contracts would fall more drastically than the far-month ones so we could reap the profit from the difference [also known as the spread].”

Back then, the team had been accumulating short positions over a two to three-month period and was just waiting for the right time to unwind their trades. What they did not expect, however, was that heavy rain would cause a flood in Johor Baru, which led to a shortage of CPO. So, instead of going down, the prices shot up.

“The flood changed everything and we could not unwind our positions, mainly because the far-month contracts were too illiquid. We held a few thousand lots in our portfolio and the far-month contracts were only trading at 100 to 200 lots a day. Eventually, it took us two months to unwind our positions,” says Tan.

As a result, their clients who had acted upon their recommendation lost money. “My clients went broke. We had a good relationship with them and we felt really bad. That was one of the biggest losing trades we recommended to our clients,” he says.

The hard-earned lesson that Tan learnt was that position sizing (the size of a position within a particular portfolio) and market liquidity matter a lot. “I learnt not to trade the far-month contracts with positions that were too big, unless I was ready for a margin call,” he says.

“Also, when trading in different markets, utilise different position sizes. A trader has to be careful about the size of the position they take in relation to the market they are trading in.”

Ang had a similar experience before joining CIMB Futures. He was a trading assistant to a remisier at OSK Securities Bhd in 2007 and was dabbling in the market by trading call warrants. “I started out with about RM20,000 and it grew to more than RM100,000 within six months. It was a handsome return and I felt like there was nothing I could not do in this world,” he recalls.

Brimming with overconfidence, Ang started to trade recklessly via contra trading, a facility provided by brokerage firms, which allowed him to buy and sell call warrants within three days without putting up any money up front. At the end of the three days, he would be paid by the firm if the price of the call warrants went his way.

Contra trading is deemed risky as a trader could overtrade and suffer huge losses. This was what eventually happened to Ang. “I overtraded. At one point, the price of the call warrant I was trading went down. This not only wiped out my gains but also left me with a loss of RM20,000.”

The lesson he learnt was to be disciplined when trading and not be overconfident. “If you start trading recklessly and do not manage your risk, you will crash regardless of the market condition. Even if the market is not volatile, you will trade in and out and lose money. When you are reckless and overleverage yourself, a small move in the market will wipe you out,” he says.

The worst losing trade for the duo, however, happened in 2013, when they shorted the KLCI before the general election. At the peak, Tan and Ang suffered paper losses of RM700,000 and RM650,000 respectively.

“We decided on the short position based on our experience in the 2008 general election, when I shorted the market as I had expected Barisan National to lose more seats. The market fell more than 100 basis points (bps) after the election and I profited from it,” says Tan.

“In 2013, we had a similar view that BN would lose more seats even though it could still win the election. We heavily shorted the market, but the index went up about 40bps after the election. Then, it went up again to about 120bps.

“That was how Ang suffered a loss that year. I was profitable despite losing about RM200,000 post-election just because I was lucky.

“I took a deep breath when I saw the losses and left my computer to get some water. I came back to the computer after a while and the index had climbed back up a bit. I suffered less than Ang when I closed my position. That was another big lesson on risk management for us.”

 

Traders are like athletes

These key lessons have served them well in their trading career. With the right mindset and trading approach in place, they have been continuously profitable in their trades since they ventured out on their own.

One of their most successful trades happened in August 2012, when they successfully shorted the FCPO. They saw a return of more than 100% in just two months.

“The CPO price went down from about RM3,100 per tonne in August to RM2,250 in October that year due to seasonal factors. CPO production was high during these months and the weather conditions were favourable,” says Tan.

“Seasonal factors such as these tend to be a recurring thing in the market. However, we positioned ourselves well back then by accumulating many short positions before the CPO prices dropped. We made one of the biggest gains in our career when we closed our positions.”

But there was a risk-return trade-off. Tan says the high returns from these trades came with higher risk. With proper risk management strategies in place, the duo were highly leveraged at 5 to 10 times during those two months.

However, they say most of their annual profits were generated through smaller trades done every day. Each trade earned them 0.3% to 0.5% and the year’s return was the result of accumulating these small profits.

“We are not moonshot traders who get famous from a particular big bet. We profit from the small trades we make each day. That is our style,” says Tan.

“As the Chinese proverb goes, ‘Sand accumulates to form a pagoda’. Another says, ‘A distant journey tests the strength of a horse and a long task proves the character of a man.’”

The most important thing that contributes to the long-term performance of a trader is discipline, he says. “When it comes to being a good trader, I would say 80% of it is discipline while 20% are the techniques and fundamentals.”

That is because nobody can predict market movements, which are driven by news flow and human emotion, he adds. However, a good trader can conduct fundamental analysis on the broader economy and utilise technical analysis to seize trading opportunities during market swings. The trader can devise a reliable trading and risk management strategy, stick to it and profit in the long term.

“You do not know how the market will behave. The only thing we can control is our behaviour,” says Tan.

Discipline not only plays an important part in trading but also in his daily life. For instance, he ensures that he gets at least seven hours of sleep every night. “If I get less than that, I will need a nap in the afternoon. I won’t be able to perform at my optimum if I don’t have enough sleep,” he says.

To stay healthy and alert, Tan reduces his intake of oily food. “I like nasi lemak, but I cannot eat it every day,” he says.

He also swims regularly and avoids alcohol to ensure that he can trade at his optimal state of mind during working hours. “A trader is like an athlete. We need to have a very disciplined life. I need to have peace of mind and keep my emotional curve as flat as possible, especially when we are experiencing a losing streak,” he says.

Ang concurs. “Discipline is the main criteria of successful trading. You have to know how to make it part of your character. Honestly, I am less disciplined than Tan. So, it has been a life-long learning process for me.”

 

A more prudent approach

Throughout their careers, Tan and Ang have encountered scepticism from investors because of their backgrounds. Unlike some of their peers, they have not worked at global investment banks such as JPMorgan Chase & Co or Goldman Sachs Group Inc.

However, Tan does not believe this puts them at a disadvantage. “We started small with our own money. We have never lost it and it gradually grew to get us to where we are today. Our experience makes us more prudent and it has trained us to focus more on risk management,” he says.

Traders who work at big investment banks are typically given a large amount of money — say, US$50 million— to trade. They tend to take more risks as they are not trading with their own money, says Tan.

Tht is why there have been cases where traders make large bets that turn sour and they eventually bring down the whole bank, he adds. “An example is Nick Leeson, a derivatives trader with Barings Bank in Singapore. The bank collapsed because he overtraded the market.”

Ang says they have invested most of their money in the fund they are managing. “This is another reassurance to investors that we will strive to generate profits over the long term and act in the best interests of the fund’s investors,” he adds.

 

Phillip Global Futures Fund

The Phillip Global Futures Fund (PGFF) is a wholesale fund with a minimum investment amount of RM100,000. There is a sales charge of up to 5% and an annual management fee of up to 2%. There is a performance fee of 20% if the net asset value (NAV) of the fund surpasses the previous high water mark. The fund also charges investors a 2% exit fee if they redeem their units in the first 12 months.

Asset allocation-wise, the fund invests up to 50% of its NAV in futures contracts while the rest is invested in liquid assets such as money market instruments or collective investment schemes.

While fund managers Tan Ken Tak and Ang Yue Enn still trade in the local futures market when opportunities emerge, most of their trading is conducted overseas.

Tan mainly trades E-mini S&P 500 Futures, E-mini Nasdaq 100 Futures, West Texas Intermediate Futures, Copper Futures and Gold Futures. Ang trades West Texas Intermediate Futures, Iron Ore Futures and Sugar Futures.

The PGFF is a growth fund, so there is a higher level of risk. Nevertheless, investors can expect a worst-case scenario of a maximum drawdown of 20%, says Phillip Mutual Bhd CEO Andy Lim.

“This means the fund will cap its losses at 20% from peak to trough. When this happens, we will either liquidate the fund or continue to operate based on the majority decision of the investors,” he adds.

Tan says the US equity market will be very challenging next year as trade war tensions and protectionism measures continue to spread globally. He expects the market to trend down and this will translate into more short-selling opportunities.

“It is a challenging year ahead. So far this year, the Chinese equity market has dropped significantly. Top performer Tencent Holdings Ltd, for instance, has seen its share price plunge about 40%. This is a clear signal from the market and an alert to equity investors. I expect more bad news than good news to come out of China’s market going forward,” says Tan.

“Meanwhile, the US market and economy have their own set of challenges, including a high level of government and corporate debt. A trade war could hurt its economic growth and cause inflation to rise further. People have to buy more expensive goods, so this will eat into their buying power.

“I believe all these are already happening, but it will take some time to be reflected in the market. So, yes, I foresee myself taking more short positions than long next year.”

Ang, who studies the commodity market, says there are pockets of trading opportunities in China’s Iron Ore Futures market. He says the supply of and demand for iron ore will remain weak because the Chinese government is cutting down on iron ore production while lower-than-expected global growth will curb the demand for the commodity.

“Nevertheless, iron ore prices could still go up 5% to 10% going forward due to the wide spread between iron ore and steel bars. The spread between these contracts is normally between 300 and 500 yuan per tonne. It is now about 1,000 yuan per tonne,” says Ang.

 

New blood needed

The futures market is small and there isn’t much new blood in the industry, say Tan Ken Tak and Ang Yue Een, fund managers of the Phillip Global Futures Fund (PGFF).

“There are about 200 local participants [of Bursa Malaysia Derivatives Bhd]. Most of them, who have been steadily profiting over the years, are in their fifties and sixties this year. We attended Bursa’s annual dinner recently and we estimated that less than 15% were below the age of 40,” says Tan.

Why is it so? He says the public, including the younger generation, has the perception that trading futures is extremely risky and tend to treat it like gambling in a casino.

“Many retail investors put up about RM5,000 — just enough to cover their initial margin — and trade one lot [of KLCI futures contracts]. When the market does not move in their favour, they get a margin call, lose some money and quit. They do not take trading seriously. There are actually many things inside, such as money management, risk management and trading strategies,” says Tan.

Ang says those interested would have to read more about trading techniques and trade every day if they want to become a professional trader. Even then, he will definitely get burnt a few times and suffer losses.

“You would need to trade every day. It is like operating a business. You run your business every day to find out the problems and improve on them. You cannot come in and out just like that,” he says.

“Then, in the middle, you will get burnt and suffer losses. Only a few people are willing to go through the whole learning process.”

This partly explains why Ang and Tan are managing the PGFF themselves even though they have been looking for someone to learn the ropes and assist them in managing the fund. “We have not been able to find the right person who has the initiative and determination to learn how to trade the market and help us manage the fund and make it profitable over the long term,” says Tan

“This is one of the key risks of the PGFF. Because if something bad happened to one of us, the other would have to manage the whole portfolio by himself.”