Anatomy of a Trend Following Breakout… Crude Oil

At the risk of being one of those people who throws a bunch of lines, arrows, and squares on a chart and says… look at this…we have re-created a chart of Crude Oil over the past 20 months to highlight how a classic trend following trade looks.

While there are hundreds of different ways to do trend following, the general idea is to bracket the market with volatility adjusted bands, and when the market ‘breaks out’ above those bands, go long – when breaking out below the lower band – go short.

We have used rather standard 80 day averages and standard deviation lookbacks to create the bands in the chart below, showing that Crude Oil broke out to the upside on 2/23.  The classic trend following trade is to go long on the open following that breakout, which was last Thursday’s open of 98.97, and risk down to the 60-100 day moving average.  In our example, we’re using the 80 day moving average (the lighter orange line), which sat $6.57 away from the entry at 92.41 on 2/24, representing $6,570 of risk on the entry day.

Crude Oil bollinger bands

Moving forward, the classic trend following model hopes prices will remain above the moving average long enough to pull that average above the entry price, thereby locking in a gain. If prices fall and the moving average doesn’t advance, the trade will lose the difference between the entry and wherever the moving average is at the time prices close back below it.

To see why and how trend following, and managed futures in general, are long volatility strategies where profits can be many times the amount risked on a trade – one only need imagine Crude Oil going to $150 on the back of an uprising in Saudi Arabia or something.  In such a case, the trade could make $50+ ($50,000) on the same initial risk of just $6,500, for a risk/reward payoff of nearly 8 to 1.   Conversely, if peace spreads across the Middle East over the next few weeks by some chance and Crude Oil sells of $50 down to $40 something, you still only lose the $6,500 (ignoring slippage and the possibility you could be locked limit down and unable to get out).

This ability to make a great deal more than you risk when volatility explodes is the classic trend following model’s calling card. The downsides, 1. only a small percentage of such breakouts may succeed and 2. Crude may go up to $140, and then all the way back down to $110, making for an overall gain, but causing pain in that your account will have given back $30 of open trade profits.

We’ll see how this breakout fares for those with exposure to the energy markets via trend following. Managers who have seen breakouts in their own models in Crude and currently hold long positions include:

2 comments

  1. […] no doubt help managed futures generally speaking, which are likely long after a classic breakout (see here), but could be hell on the rest of the world… What would $5.00 gasoline by memorial day weekend […]

  2. I often wondered what “breakout” really meant in terms of actual numbers, but now I get it (this would explain why I’d see different values for breakouts within the same chart, which is something that never made any sense to me)

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The performance data displayed herein is compiled from various sources, including BarclayHedge, RCM's own estimates of performance based on account managed by advisors on its books, and reports directly from the advisors. These performance figures should not be relied on independent of the individual advisor's disclosure document, which has important information regarding the method of calculation used, whether or not the performance includes proprietary results, and other important footnotes on the advisor's track record.

Benchmark index performance is for the constituents of that index only, and does not represent the entire universe of possible investments within that asset class. And further, that there can be limitations and biases to indices such as survivorship, self reporting, and instant history.

Managed futures accounts can subject to substantial charges for management and advisory fees. The numbers within this website include all such fees, but it may be necessary for those accounts that are subject to these charges to make substantial trading profits in the future to avoid depletion or exhaustion of their assets.

Investors interested in investing with a managed futures program (excepting those programs which are offered exclusively to qualified eligible persons as that term is defined by CFTC regulation 4.7) will be required to receive and sign off on a disclosure document in compliance with certain CFT rules The disclosure documents contains a complete description of the principal risk factors and each fee to be charged to your account by the CTA, as well as the composite performance of accounts under the CTA's management over at least the most recent five years. Investor interested in investing in any of the programs on this website are urged to carefully read these disclosure documents, including, but not limited to the performance information, before investing in any such programs.

Those investors who are qualified eligible persons as that term is defined by CFTC regulation 4.7 and interested in investing in a program exempt from having to provide a disclosure document and considered by the regulations to be sophisticated enough to understand the risks and be able to interpret the accuracy and completeness of any performance information on their own.

RCM receives a portion of the commodity brokerage commissions you pay in connection with your futures trading and/or a portion of the interest income (if any) earned on an account's assets. The listed manager may also pay RCM a portion of the fees they receive from accounts introduced to them by RCM.

See the full terms of use and risk disclaimer here.

Disclaimer
The performance data displayed herein is compiled from various sources, including BarclayHedge, RCM's own estimates of performance based on account managed by advisors on its books, and reports directly from the advisors. These performance figures should not be relied on independent of the individual advisor's disclosure document, which has important information regarding the method of calculation used, whether or not the performance includes proprietary results, and other important footnotes on the advisor's track record.

Benchmark index performance is for the constituents of that index only, and does not represent the entire universe of possible investments within that asset class. And further, that there can be limitations and biases to indices such as survivorship, self reporting, and instant history.

Managed futures accounts can subject to substantial charges for management and advisory fees. The numbers within this website include all such fees, but it may be necessary for those accounts that are subject to these charges to make substantial trading profits in the future to avoid depletion or exhaustion of their assets.

Investors interested in investing with a managed futures program (excepting those programs which are offered exclusively to qualified eligible persons as that term is defined by CFTC regulation 4.7) will be required to receive and sign off on a disclosure document in compliance with certain CFT rules The disclosure documents contains a complete description of the principal risk factors and each fee to be charged to your account by the CTA, as well as the composite performance of accounts under the CTA's management over at least the most recent five years. Investor interested in investing in any of the programs on this website are urged to carefully read these disclosure documents, including, but not limited to the performance information, before investing in any such programs.

Those investors who are qualified eligible persons as that term is defined by CFTC regulation 4.7 and interested in investing in a program exempt from having to provide a disclosure document and considered by the regulations to be sophisticated enough to understand the risks and be able to interpret the accuracy and completeness of any performance information on their own.

RCM receives a portion of the commodity brokerage commissions you pay in connection with your futures trading and/or a portion of the interest income (if any) earned on an account's assets. The listed manager may also pay RCM a portion of the fees they receive from accounts introduced to them by RCM.

See the full terms of use and risk disclaimer here.