How to assess and minimize the risks of PAMM Account
Profitability volatility is one of the main criteria for assessing the risk of a PAMM account
PAMM Account Monitoring Service provides an extensive overview of tools for analyzing the work of managers. In general, all monitoring indicators are divided into two groups: some reflect the effectiveness of the trading system, its ability to generate profit, and others reflect how well money is managed on the PAMM account. One of the main criteria, demonstrating how consistently the rules of money management are followed on the account, is an indicator of volatility.
Sometimes both investors and traders confuse the concepts of PAMM-account profitability volatility and currency pair volatility. These concepts should be separated. The volatility of a currency pair shows how many points the exchange rate of a particular currency in relation to another changes per unit of time, for example, in a day. This indicator can be different and varies for major currencies, as a rule, in the range of 50-200 points per day. The volatility of the PAMM account is the fluctuation in the daily profitability of the PAMM account, measured in percent. Mathematically, account volatility is the ratio of daily profit or loss to the size of funds in an account.
For a certain period, volatility can be average and maximum. Average volatility characterizes the aggressiveness of trading on the account for a certain period of time. It shows what share of the PAMM-account funds the manager is ready to take risks with. In general, if the volatility indicator does not exceed 5%, it is safe to say that the loss limit is used on the account, and a quick drain is unlikely to happen – unless there is a technical error on the side of the manager or some force majeure the market. The disadvantage of this indicator is that the volatility of daily returns is the arithmetic average of all daily returns. That is, this indicator does not show how strong fluctuations in profitability on individual days are. It may well be that the average account volatility is 10%, and the maximum daily loss is 90%, that is, a little more, and the account could be emptied. Therefore, when assessing risks, the maximum daily volatility should also be taken into account.
Maximum daily volatility is the maximum loss or profit taken modulo. This indicator demonstrates how much the trader can sometimes “get stuck”, and how much he is ready to “draw down” his account.
Returning to the confusion of the concepts of the volatility of the profitability of a PAMM account and the volatility of a currency pair, it makes sense to note the following. It is often heard that when a volatility of a currency pair changes, a change in the volatility of a PAMM account is normal. It’s hard to agree with that. Indeed, an increase in account volatility leads to increased risks. And this, in turn, is a diversion from the rules of money management. Therefore, when the volatility of the currency pair being traded increases, nothing prevents the PAMM-account manager from decreasing the lot size; so that the volatility of the account remains at a given level. This statement makes sense in situations where increase in the volatility of a currency pair leads to pushing apart of Stop Loss and Take Profit values.
In general, we can say that for investing with the same profitability it makes sense to choose the PAMM account, the volatility of which is less, because in this case the risks of losing your money as an investor are much lower. When choosing a PAMM account, a pretty good indicator is the ratio of account profitability (expressed in share price) to the maximum daily loss (or profit, whichever is greater by modulus). Ideally, the logarithmic ratio of these quantities should be considered.
As you know, you can earn much more on Forex than when opening a bank account. But the risk of losing your savings here is much higher. This applies not only to traders, but to investors in PAMM accounts. A logical question arises: is it possible for an investor to significantly reduce risk while maintaining profitability at an acceptable level. The answer will be yes: yes, you can. To do this, the investor must correctly compile an investment portfolio of several PAMM accounts.
Why do you need a PAMM portfolio?
One PAMM account, no matter how profitable and reliable it is, in any case carries significant risks. Therefore, to minimize risks, a PAMM portfolio is created consisting of several PAMM accounts.
You can, of course, open the rating of PAMM portfolios and take advantage of a ready-made investment offer, without really going into the study of the criteria for selecting PAMM accounts for investment. In this case, however, two things must be taken into account:
In addition to paying remuneration to the managers of PAMM accounts, you will also need to pay a fee to the manager of the PAMM portfolio.
You cannot be completely confident how well the manager has formed his investment portfolio.
Or you can spend a little time and learn how to choose PAMM accounts for investment yourself. Select multiple accounts according to criteria such as potential profitability, drawdowns, risks, age of accounts. At the very least, you will be sure that the accounts in your portfolio fell according to the specified criteria, and not because someone just wanted to include them in their portfolio. Well, save on commissions for managing the PAMM portfolio, of course.
Suppose you have selected several potentially attractive PAMM accounts for investing. Now it remains to understand how many of them should be in the portfolio, and in what proportions the shares are distributed. It is believed that there should be 5-10 accounts in the PAMM portfolio. If less than 5, then diversification will be insufficient. If more than 10, then with so many accounts it will be quite difficult to keep track of. In addition, according to popular opinion, the share of conservative accounts, with a high degree of reliability and, accordingly, with not the highest potential profitability, in the portfolio should be 70-80%. Accordingly, the share of aggressive ones is 20-30%. With this ratio, the profit received from investments in aggressive accounts may be even greater than from investments in conservative ones, despite their higher share in the portfolio. And if any of the aggressive accounts makes a loss, this will not critically affect your financial well-being due to the low share of funds invested in this account in the PAMM portfolio. Moreover, in any case, you have good chances to get the total profit from the PAMM portfolio, since conservative accounts, albeit little by little, should be profitable.
In conclusion, we should dwell on this aspect. When selecting PAMM accounts, it often turns out that several of the most successful accounts are managed by the same manager. So, it makes sense to invest in only one of them, since usually on all these accounts trading is carried out approximately according to the same system. The difference between one PAMM account and another is only in the level of risks and, accordingly, profitability. In the event of any malfunction in the system, you will receive a loss on several accounts at once, if you invest in more than one PAMM account of one manager.
Author: Kate Solano, Forex-Ratings.com