What to look for when investing in FX traders
We have been analysing traders and allocating to them since 2004 and here are some of the conclusions that we have reached:
- Around 1:880 retail traders is worth considering. Not an overly impressive number but really not surprising when you think that the vast majority of retail traders have had no formal training in the financial markets and are trading part-time at best.
- Former interbank traders don’t transition well to the retail space. The really good ones can make millions for themselves and aren’t interested in managing other peoples money. The rest probably relied heavily on corporate flows to make their money at the bank and can’t do it when on their own.
- Always insist that data analysis is carried out on equity performance and not on closed-trade performance. The latter can hide a lot of poor trader behaviour.
- Just because a trader can make money consistently on a $10k account does not mean that they will make money on a $1million account. The psychological aspect is huge and we find that most traders with potential will founder and change behaviour to their detriment once AUM increases. The exceptions are the ones whose focus and performance actually improves once the AUM goes up; these are the diamonds that we are constantly seeking.
- Avoid Martingale traders at all costs. These are very prevalent in the retail space. They continuously book small profits thereby making themselves look good but once they are out-of-the-money on a trade they start doubling up and running bigger positions over risk events. There is a 100% mathematical certainty that these types of traders will eventually blow your account up but probably after they have already been paid a few months commissions during times when they got away with it.
- Get to know the trader. Find out their background and where they have traded. Ask for references. If there are multiple excuses re the lack of a track record and/or references, then look elsewhere for your trading talent.
- “Lies, damned lies, and statistics”. Don’t always trust the numbers! Get to know the trader.
- Set firm rules in terms of your own personal drawdown policy. Remain in control, don’t let the trader tell you what the limits should be.
- Start with a small allocation. If the stats and the background are confirmed by the small allocation, then you can consider some incremental increases.
- Don’t be overly concerned by managed losses; every trader will have ups and downs. Be very concerned by bad trading behaviour and cut the trader’s allocation immediately.
- Find an honest broker. The counterparty risk is probably just as big as the trader risk so do your homework and try to find a broker who wants long-term business not the churn-and-burn variety. If this means settling for much lower leverage and increased oversight then so be it.
- Finally, this is a space for sophisticated investors who understand exactly what they are doing and are looking to take on some additional portfolio risk. Don’t listen to all the hype. If you don’t understand the risk, the trading strategy, the trading conditions etc, then look for something else more suitable to your personal situation.