Recovery factor as one of the most important indicators of a PAMM account
One of the most important indicators of the reliability of the trading system used in the PAMM-account is the recovery factor. It is this factor that investors should study closely when choosing a PAMM account. Recovery factor shows how quickly the system recovers its profitability after drawdowns. Mathematically, this is the ratio of the profitability of the account to its maximum drawdown, that is, this parameter shows how many times the current profitability of the PAMM account is greater than its maximum historical drawdown.
The charm of the recovery factor is that this indicator allows you to combine such criteria for assessing the attractiveness of a PAMM account as profitability and possible drawdowns. It often happens that you look at the account and see profitability of several thousand percent. And then you look at historical drawdowns and understand that drawdowns of 80–90% are unlikely to suit you. You go to the next account and look through a bunch of PAMM accounts. As a result, the head is spinning and it is completely unclear which manager should be preferred in terms of the profitability / drawdown ratio. But if you sort PAMM-accounts in the rating by such a criterion as a recovery factor, you can rank them in terms of the reliability of the trading system used. For reliability, you can sort the accounts for several time intervals: six months, a year, and for the entire life of the account. It makes little sense to consider shorter time intervals, since investing in a PAMM account with a life of less than six months is a rather adventurous beginning. In this case, the recovery factor may appear in a very distorted form as a result of insufficiency of the statistical sample, since the account just did not fall into its normal drawdown, and simply because of a happy coincidence.
Naturally, the recovery factor is not an exhaustive criterion when choosing a PAMM account. It is also necessary to take into account risks, account age and other parameters. It must be remembered that the recovery factor shows the degree of system reliability, but says absolutely nothing about the ability of the account manager to manage capital. After all, such a situation can happen that a PAMM account has an excellent recovery factor, an excellent profitability of thousands or even tens of thousands of percent, but the drawdown on it was 95%. How justified would be investing in such an account? As a part of your portfolio which you are not afraid to lose, this will be a good choice. But investing all your money in such a PAMM-account will be very risky, since the manager of this account has great doubts about the knowledge of money management. Perhaps the manager knows what money management is and consciously takes such a risk, trying to get as much profit as possible. But in this case, investing in such an aggressive account will be no less risky.
Thus, the following conclusion can be made: the recovery factor should not be the only criterion when selecting a PAMM account for investing. But its importance for assessing the degree of reliability of the trading system is second to none.
Why do I need a Leverage indicator?
All novice investors should know how to correctly apply the analysis of Leverage indicator when selecting PAMM accounts for their portfolio.
First, recall the definition of leverage used. Leverage is the ratio of the nominal volume of open orders to the amount of funds in the account. That is, if you have an open order EUR / USD with a size of 1 lot, at a rate of, say, 1,0800, and funds in the account 6,000 USD, then Leverage = 108000/6000 = 18. Is it a lot or not? It is impossible to unequivocally answer this question, since the value of leverage itself does not mean anything. For example, with short “stops” of several tens of points, higher values of the leverage used are acceptable than with Stop Loss levels of several hundred points. That is, if one account has a leverage of 10, and the other has a leverage of 30, this does not mean that an account with a large leverage has 3 times higher risks than another. Therefore, the dynamics of leverage in relation to the dynamics of profitability of the analyzed PAMM accounts is what interests us most.
Studying the leverage schedule gives quite a lot of important information about the working style of the manager of the PAMM account. For example, you can see how many orders the manager opens, when exactly they are opened and closed. But, first of all, the analysis of the dynamics of the leverage serves to assess how quickly the account can be drained, that is, to assess the risk measure when investing in one or another PAMM account. Quick drain signals about trading without Stop Loss in general and the Martingale system in particular. In general terms, “Martingale” is a strategy that provides for a multiple (usually double) increase in the volume of an open order when the previous order reaches a certain level of loss.
Of course, trading without a loss limit has the right to life, but the investor must clearly be aware that such an account in the event of a strong price movement can turn to zero. Therefore, if you want to be an investor counting on long-term profits, and not a casino player, you need to learn how to recognize PAMM accounts that use trading without loss limitation.
So, how to determine an account that is traded without loss limits? Another such strategy is called “sitting through losses”. This is when the price movement in the direction of an open order that is not favorable for us increases the loss. The manager, however, expects that the price will turn around sooner or later and go in the right direction. The problem is that it can turn around even when the account is liquidated, because there was not enough deposit size. Or, the value of the currency pair exchange rate can go so far that its return to the breakeven point can be expected for years. On the leverage chart, such a trading method is displayed as follows: simultaneously with an increase in profitability, the size of the used leverage increases. If the profitability of the account decreases for a long time, and the leverage grows, then this is a clear sign of trading without limiting losses. If periodically, with a decrease in profitability, the value of the leverage is reset or decreases, this means that the manager applies a loss limitation, and investments in this PAMM account carry much less risk.
The Martingale strategy according to the leverage chart used can be calculated as follows. The leverage jumped from zero to some value - which means the deal has opened. Then it can be seen that after some time, usually immediately after a sharp decline in profitability, the value of the leverage suddenly increased, usually another 2 times. Then for the third time there is a sharp increase in leverage. Then the leverage is reset at the same time as a sharp increase in profitability. Moreover, the yield, as a rule, becomes higher than it was before the opening of the transaction. You can be sure that Martingale is in front of you. And sooner or later, such an account will be instantly drained. A small clarification: it is best to analyze the leverage schedule on hourly intervals.
Thus, we can draw the following conclusion. A flat graph of leverage, when its daily value is either zero, or fluctuates around a single value, and then is reset again, indicates that investing in such an account is much safer than one that is characterized by sharp jumps in the value of the leverage with drawdowns on the yield chart.
Naturally, it is fundamentally wrong to make a verdict on including one or another PAMM account in your investor’s portfolio based on an analysis of the leverage used, since a high leverage in itself does not mean high risks. You need to use several analysis tools, which brokers provide in abundance for the analysis of PAMM accounts.
Author: Kate Solano, Forex-Ratings.com