When Money Management Goes Wrong : What Happens When Traders are Irresponsible

When you think about forex managed accounts you definitely get the idea that someone who is a capable professional and profitable forex trader will manage your funds trying to maximize your potential gains while keeping your risk to the minimum possible or highest agreed value. Certainly it is very horrifying to see how most forex money managers have no more experience than most novice traders out there and simply no idea about money management or long term profitability in forex trading. Sadly when this is coupled with the general practice of people trading the accounts with the “most profitable results” a dynamite combination is generated when people are only waiting to see their accounts pulverized.

On today’s post I want to talk to you about what happens when money management “goes wrong” (with a very clear example) why this happens and what can be done to avoid such a scenario. I will show you a real case of a fund which reached almost 750K USD  after the manager had some great returns between Oct-Nov 2010 and how this person later obliterated the whole account through irresponsible trading done in order to desperately recover and reach new equity highs.

Who are most forex PAMM account money managers ? Who are these guys with websites offering to manage your forex account through a LPOA ? The truth is that most money managers are just traders who want to “get rich quick” who have seen in managed forex account trading the possibility to do so with very limited risk to their actual trading capital. If you look at a true audited track record of most managers out there you will see that their trading experience is probably limited to a very small time (usually less than a year) in which they might or might not have achieved very good returns. To make things worse, these managers usually have a very limited experience about the market and no knowledge about the long term statistical character of their trading methods and practices.

Why do investors put their money with these people ? A very simple reason : performance. When people start to look for forex managed accounts they are usually told that “all return levels are possible” and when they see an account that has been giving a 100-200% return per month they simply cannot help it and join the account with the hopes that this performance will be repeated at least for a few months so that they can withdraw profits and continue trading with “house money”. Certainly there is a group of people – and a quite large group that is – which will always go with the forex managed account that has the highest returns regardless of the amount of risk that is being implicitely taken with the trading tactic being used.

The problem here is that investors lack the necessary knowledge to discriminate between a good and a bad manager. What makes a guy who has been making 100% a month better or worse than a guy who is making a lower return ? The answer is probably related to the implicit risk which is being put on the account. Whenever a position is taken within a certain method or tactic there is a certain implicit risk associated with this position which will be eventually cashed by the market. The difference in quality between one manager and another is simply the level of knowledge they have about this implicit risk level.

For example, a guy named Maurizio opened up a PAMM called “Bazooka” on FXOpen, an he took the account to a massive 700% gain within a few months, gaining more than 20 investors and a capital of more than 700K in a very short time. At that moment you would have thought that his PAMM was simply “the best” but within his trading record you could see a very high market exposure which was yet to be cashed by the market. When this happened – and it always happens – the account took a plunge which took it to an equity low of -97% effectively destroying a massive amount of funds and losing the money of all investors.

This guy killed his account because he totally ignored the eventual exposure he was getting into. Certainly he mentioned that the account was “high risk” but certainly this doesn’t mean for most people that the account will be traded in a reckless fashion with desperate attempts to recover and the almost total wipeout of their account’s equity. Sadly this is not the “odd case” but more the norm of forex managed account services. Most money managers completely ignore the exposure of the way in which they are trading and obliterate accounts through the use of reckless trading tactics and poor emotional intelligence.

The solution to this problem is to trade with money managers who have a very good idea about their account’s market exposure. A manager who knows exactly what historical risks the trading methods used have been exposed to and who can give a clear number for when the strategy stops working. A good manager will always let his or her investors know exactly what the statistical characteristics of the investment might be and what levels of possible profit or loss might be expected in the future. A good manager NEVER does reckless trading, ALWAYS controls the risk per position and ALWAYS explains what is being done to his or her investors. Long story short, a good money manager is a manager who doesn’t surprise investors in anyway, a manager who has a very deep knowledge about how an account is being traded and who has communicated this knowledge in a transparent and open way to his or her clients.

This is certainly what we want to achieve with the AIP (which should start trading soon!) a team of money managers who behaves in a very ethical and informed manner without ever surprising clients with dismal draw down levels and “roller coaster” trading. Whenever extremely high returns are seen, extremely high draw downs are expected. Market exposure is always implicitly present (regardless of the trading strategy) and it will always get cashed. Knowledge about the magnitude of this exposure separates good from bad money managers.

If you would like to learn more about my work in automated trading and how you too can develop your own systems with sound trading tactics and a correct assessment of their long term statistical characteristics please consider joining Asirikuy.com, a website filled with educational videos, trading systems, development and a sound, honest and transparent approach towards automated trading in general . I hope you enjoyed this article ! :o)

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One Response to “When Money Management Goes Wrong : What Happens When Traders are Irresponsible”

  1. Maurizio says:

    Hello Daniel, I hope that every reference to real persons is casual relating to the PAMM example… :o) I’m a conservative and thoughtful trader and would never open a such account. But this give me the occasion to tell what happened to me, which is directly tied to your article.
    3 years ago I invested in a Forex managed account here in Switzerland after I loosed money in a stock investment with a bank. At that time I did not have any knowledge about Forex. The manager took advatage from my ignorance, promised me an annual average return of 20-30%, showed me a too short track record and I trusted him. Result: 45% of my account lost in 2 months. Fortunately I decided to stop although he promised me to recover quickly. Now when I get a look at that statement, I see a lot of errors in basic money and risk management. That manager was regularly approuved by the FINMA, which is the regulatory authority here in Switzerland. The second big mistake in my managed investment “career” was with an regular registered hedge fund, which had a 3 years track record with a 50% average annualised return. Result: 96% loss in a single day in the october 2008 crisis. Unfortnately, these are true stories. So, long story short, I warn everybody from trading blackboxes. A managed account is a blackbox unless the manager and the strategy are absolutely transparent, as you are planning to do within the Asirikuy PAMM annount project. PAMM accounts are mostly blackboxes, Zulutrade accounts or similar website accounts are blackboxes. Hedge funds are blackboxes. Everything we don’t know in every details is a blackbox. After those bad experiences I decided to trade personally my money and to never let others trade them any more. And following Asirikuy philosophy and strategies I’m sure I’m on the right way.
    Regards.
    Maurizio

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