Hedge funds and Commodity Trading Advisors (CTAs) make money in commodity market futures by trading momentum and volatility. They buy markets that they hope will keep going up and sell short markets that they hope will keep falling. Today, we'll discuss how hedge funds trade and how we can see evidence of this in the market.

At Peak Trading Research, we specialize in quantitative commodity research and focus on modeling market participant behavior, especially quantitative traders like hedge funds and commodity trading advisors (CTAs). Most hedge funds and CTAs in commodity market futures are momentum traders, hoping to buy into a market that's rising, so they can sell at a profit.

For example, in February and March 2022, supply chains were tight, China was locking down with Covid, and commodity markets that were sensitive to Black Sea production or Russian exports, like wheat, crude oil, and natural gas, saw a rise in prices due to Russia's invasion of Ukraine on February 24th.

According to the weekly commitments of traders reports published by the US government, hedge fund speculators were buying into this upward momentum, and their aggregate investment in commodities across energy, metals, and agriculture markets got up to $170 billion by early March 2022, decade-high levels.

Peak Trading Research's proprietary CTA ladder model, which quantifies the aggregate positions and profits of momentum trading CTA traders, confirmed that most CTA traders were long commodity futures across agriculture, energy, and metals markets, making strongly positive profits.

The SocGen CTA Index and the SocGen CTA Trend Index, which capture the performance and profits of different CTA traders, also revealed that these commodity trading firms made a lot of money trading the momentum and big volatility in the spring of 2022.

A practical example of how a hedge fund might buy commodity futures on upward momentum is a simple momentum trading strategy on heating oil. This breakout strategy buys if the market is closing at the highest level of the past 20 price bars and sells short if it's falling.

The system has a stop-loss and will get out after 40 bars if there's no other trading signal. This strategy made about $180,000 per single contract of heating oil traded over the past five years, and its equity curve looks similar to the performance of the SocGen CTA indices.

Effectively, a very simple breakout momentum trading strategy on one market, on just the heating oil market is a great proxy for how this entire industry trades, buying upward momentum, hoping prices keep rising for a profit, selling short downward momentum, hoping prices keep dropping for a profit. That is these hedge funds’ ‘bread and butter’ trade.

In summary, hedge funds and CTAs position themselves to buy upward momentum, hoping prices keep rising for a profit and sell short downward momentum, hoping prices keep dropping for a profit.

We can see evidence of this in government positioning reports, Peak Trading Research's research, SocGen profitability indices, and a simple breakout trading system that acts as a proxy for the entire hedge fund industry.

Hopefully, you now have a great sense of how hedge funds and commodity trading advisors position themselves and make profits in commodity market futures.

If you'd like a trial of our quantitative commodity research, you can reach out Insight@PeakTradingResearch.com.