There have been quite a few winners and losers in the immediate aftermath of the 2011 crash (does this move have a name yet?), and one of the biggest losers has been discretionary trader Dighton Capital. We posted their ‘defense’ of their position two weeks ago, but things went terribly wrong since then, with a dramatic move higher in the Swiss Franc causing losses of more than -50% for Dighton in August (on top of -30% losses in July), putting the drawdown on their composite track record at a disturbing -76%.
What happened? Several clichés come to mind. Mess with the bull, get the horns; you’ll run out of money before the market returns to sanity; don’t get married to a trade… just to name a few. But this wasn’t some novice trader throwing a trade against the wall to see if it would stick. Dighton had been here and done that before. Yes, they were a high risk/high reward type of strategy, but still we’re talking about professional traders with over $100 million in assets under management and 8 years of history.
In the end, Dighton followed their usual discretionary trading pattern of taking a contrarian stance against an outlier move – and adding to the position as the trade went against them. But unlike their past successes with this strategy, this outlier simply didn’t revert to the mean. It kept going and going, past all time highs, past resistance, through central bank intervention – and more. It went so far it could very well have cost them their business.
Can they recover from this? The immediate problem is that it takes a huge gain to climb out of a hole this large. Consider the following chart which shows they would need to gain 300% to earn back the losses they have encountered. Our best guess is that they close up shop…
What could investors in Dighton have done differently? Could Attain have sounded the alarm sooner? Based on the breakdown of this trade, there isn’t a whole lot which could have been done differently from what we can see.
To start, Dighton was a known quantity in terms of its risk, with multiple drawdowns of over -45% in the past – meaning a loss of -50% in the future shouldn’t have surprised anybody. Additionally, this wasn’t a trade outside of their normal strategy, as they add to losing positions and sell into rallies as a matter of practice.
They were communicating throughout the trade, giving their reasons for the stance they were taking – so there wasn’t a ‘rogue trader’ aspect. And up until just a handful of days ago, the trade was within their worst past max drawdown levels.
All in all, it was a perfectly normal Dighton trade – that simply went bad in a hurry.
What are the lessons to be learned from this flame out? One, discretionary managers without set risk per trade limits carry a unique set of risks which aren’t shared by their systematic counterparts (namely that they can/will hold onto a trade a little longer if they have a heavy conviction). Two, contrarian/counter-trend/mean reversion strategies carry unique risks (the market may not mean revert). Three, be wary of investing in a managed futures program doing something different than the typical managed futures trend following type strategy (it may suffer right along with your traditional investments when a crisis hits). Four, there is risk in managed futures-there will be losses. The key to surviving such losses is to be diversified (clients invested in trend followers alongside Dighton were making money on long Swiss Franc trades right alongside Dighton losing money on it – a wash). And five, the disclaimers pasted all over our website and the rest of the industry aren’t just there for fun; there is truth in those words – past performance is not necessarily indicative of future results.
We’re hopeful investors in Dighton were diversified across strategies of different types, and have survived to fight another day, as it doesn’t look likely Dighton itself will be so lucky.
August 12, 2011
actually, I think the drawdown is closer to 90%
August 12, 2011
The only lesson to be learned from this is that anybody who takes highly leveraged risks is eventually going to be hit by an outlier event that wipes them out. This most certainly has nothing to do with discretionary vs systematic/trend following strategies. Any strategy that employs extremely high leverage given the assets they are trading and their level of diversification is at high risk. Unfortunately, such blowups confirm the views of some that CTAs can best be described as gamblers.
August 12, 2011
Be systematic or discretionary poor money management only needs one trade to go sour to wipe you out.
August 12, 2011
What could Dighton investors have done better? Not invest with him! I spoke with them a few months ago and I was absolutely scared about what I saw. He did exactly the same thing a couple of years ago with the Oil trade: Taking big position risk + no risk limits + averaging down + praying you are right. I don’t even understand how anybody can charge money for doing that, it baffles me.
August 13, 2011
[…] the article here: The Trade that Killed Dighton Capital? « Managed Futures Blog Posted in Uncategorized | Tags: dighton, its-risk, known-quantity, over-45, past, […]
August 13, 2011
[…] post: The Trade that Killed Dighton Capital? « Managed Futures Blog Posted in Uncategorized | Tags: dighton, its-risk, known-quantity, over-45, past, […]
August 14, 2011
A strategy of betting against outliers has a payoff profile similar to selling insurance: high win rate but low payoff ratio (avg win / avg loss). Sharpe ratios are not informative in this case, due to the presence of a negative skew in the return distribution.
Also, hedge fund managers may have an incentive to pursue this type of strategy because their compensation scheme is analogous to being long a call option; high watermarks are a mitigating factor.
I would be wary of negative-skew strategies unless trades are backed by a strong fundamental rationale and subject to systematic rather than discretionary risk control.
August 14, 2011
Another great advert for trend following as if one were needed. Nothing is a surprise to the initiated.
August 14, 2011
[…] The fact is that if you are entering into a mean reversion trade with a limited amount of upside then you must have a clearly defined risk which is expressed through the implementation of a predetermined stop-loss for the trade. Those who enter into mean reversion trades without stop losses are inviting themselves to BLOW UP: […]
August 14, 2011
Perhaps they should have read the “10 Golden Rules To Blowing Your Trading Account Out”.
https://bit.ly/pTzzLC
Item #2 is what seemed to sign their death warrant.
August 15, 2011
https://www.attaincapital.com/alternative-investment-education/managed-futures-newsletter/financial-investment-advisor/7
Should you not have picked up on this “betting against the trend” back then? 🙂
August 15, 2011
[…] The fact is that if you are entering into a mean reversion trade with a limited amount of upside then you must have a clearly defined risk which is expressed through the implementation of a predetermined stop-loss for the trade. Those who enter into mean reversion trades without stop losses are inviting themselves to BLOW UP as many have done recently : […]
March 2, 2013
If somehow Dighton had stayed in its positions, the profits would have been beyond wildest dreams, SF went down from 1.3 to parity, almost 30% drop from the peak within 6 months. It shows how the money management is important, you must have enough capital to survive the extreme move and if you get stopped out, courage to go back and establish your positions.