Has artificial intelligence ended hedge fund short-term trading?

It seems that robots and trading algorithms are destroying the hedge fund industry.

That is what the manager of one of the most powerful hedge funds in the industry, Stephen Jamison (Koppenberg Macro Commodity Fund) said.

In fact, the situation seems to be so bad that the find is closing right now, by the end of January.

Curiously, some years ago these funds were very trendy, as we can see in articles in Reuters, where we could see that Jamison´s hedge fund was doubling its capital due to its success.

In other, words, we have a fund that has gone to glory to death in just 4 years.

After the 2008, the commodities rebounded very strongly, with great energies and metals bull market until 2011. That is why, supposedly, Jamison´s fund had great returns from 2010 to 2012 (18, 8 and 2.7% respectively).

commodities trading machine
Good bull market in commodites from 2009 to 2011

With this data people was willing to participate in “commodities success” and, therefore, Jamison´s fund was one of the most desired.

We can see how easy the “best funds” become the “worst funds” in a matter of a few years”.

Let us have a look about why this fund was supposed to be successful.

If we see the original Reuters article, years ago, the message was that the fund behaved well when there was a bull market in commodities, from 2009 to 2011, for instance.

We can deduce that Jamison used to apply trading strategies that took advantage of the medium or long-term bull market in commodities, hence the good results those years.

However, if we look at the commodities charts after 2011 we can notice that there has been a difficult time for bull investors in those markets.

commodity hedge fund shuts
after 2011

End of the hedge funds due to increased trading algorithm activity?

I have to reckon that this recent article about the closing of hedge funds is quite confusing, or at least it looked that way to me.

Eventually you do not know that if this manager is right about the fact that machine trading has finished hedge fund success in the short-term markets, or if it is just a sign of impotence because the commodities niche did not behave well lately.

Let us have a look.

The problem lies apparently in two facts:

  • That the machines and artificial intelligence, whatever it is, make it impossible to have successful short-term strategies.
  • That the commodities do not offer any advantage to invest in the long-term, since they do not offer dividends or coupons. Besides there is no appreciation in price.

Artificial intelligence in commodity short-term trading

Well, I will try to dismantle this quote.

If that was true, then artificial intelligence would have destroyed, not only, short-term trading in commodities, but also in every other nice, including stocks. However, there are many hedge fund managers who are doing quite well. So that should not be an excuse.

In other words, if other hedge funds are being successful “now”, does it mean that they are trading well and Jamison is not?

That sounds like that actually.

Well, in this case Jamison can say that other hedge fund invests in stocks and bonds and that those behave well in the long-term, hence the funds invested in them make money.

Ok, but then, what he should admit is that his fund does not make money because the long-term trend of commodities is not good, at least in the last 5 years. In other words, we should go to point 2.

That does not mean that the machines are not influential nowadays in the markets. In fact, most dealers need automatization and more robots and algorithms to be able to compete in the market.

This is something that affects the dealer side of the equation, for sure.

In the trader side, however, either hedge funds or retail traders can use “algorithms” and robots. There is no restriction to them.

It means that any hedge fund can hire good developers to implement “good short-term trading robots”.

However, in my experience, most of those automated strategies that are put into work by and for retail traders end up in disaster.

They fail not because they are not complex, but because to do frequent trading from the traders perspective you have to do really well. I mean, really, really well.

Another thing is when we take the dealers into consideration.

In this sense, it would be good to know what type of short-term trading strategies Jamision was talking about. I would like to know if his fund was trying to short-term trade as a dealer or as a trader. The difference between those options is like day and night.

Long-term investment in commodities

As for the point 2, here we really have some logic argument about why hedge funds or any fund, in fact, that has tried to invest in commodities the last years has failed.

You only need to have a look to the charts in the grains or metals in the last years to realize how difficult it must have been for investors in those niches.

Of course, trading in commodities is very difficult like that.

This will not give you dividends or coupons in the long-run.

If you want dividends you have to buy stocks related to those assets.

If what you want to do is trading in those assets using futures or other instruments, you will, obviously, need volatility; otherwise you will be playing a losing game.

For example, if we see the last 5 years oil chart, we will notice that it has been a complete disaster, at least from the point of view of “investing in commodities”.

However, if those funds are really traders as they claim, why do not they trade the short-side of the market, for example in 2014 in oil?

Well, maybe because the short-side is very difficult to trade and those hedge funds only want to trade the long-side.

If those hedge fund managers were trading in the same way as traders are supposed to do, whether in the bull or in the short side, they would have had no problem in making money.

As with the fact that things have not been very good for the commodity sector in the last two years, it is understandable.

As I said, many of those markets are “dead”, like metals, corn, wheat, sugar or natural gas.

corn investing trading

With such markets it is very difficult to do bullish trading, not to mention investing.

Nonetheless, and as a curiosity, the main commodity market, oil, has had a big bull market, from a year or so, rebounding from 42 until 66, more than a 50% rise.

short term trading oil
good breakout at 54

In this case I even got enthusiastic and bought some positions from 54 dollars, since I saw a good possibility that the next breakout could be of a considerable amount.

From that price on and applying bullish trading strategies I have managed to maintain my position until today, with a 20% rise, which is not that bad for this difficult environment in commodities.

Conclusion

As we see the opportunities in trading in these markets have been quite scarce, due to the absence of volatility in many of them, but that does not mean they have ceased to exist.

The oil example is quite clear.

It has given both bullish and bearish opportunities to trade in the last years, from 2014 to now so there is no excuse as to say that from a trader´s perspective there was no chance to make money.

If you lose money as a dealer, that is another story though.

The problem with niche hedge funds is that they will always face bad streaks when their particular assets suffer bear markets. Because, you know, all assets have a bear market eventually.

That is intrinsic to investing and trading.

I have never seen people or assets winning every year all the time.

Even in stocks, the best of all “niches”, suffer terrible years from time to time. If you do not believe me ask the Japanese and their “3 lost decades”.

The key here is to try to take advantage of the good cycles and try to get out in the bad ones. But that is difficult, because the tendency of the masses is the opposite: buy when the markets have outperformed (expensive) and sell when they have underperformed (cheap).

All in all, I think that the closing of this hedge fund has more to do with the fact that its niche has not had good years, and that is very difficult to tell to their investors.

I do not think it has to do really with “artificial intelligence trading or machines”.

Regards and good trading.