Many different brokers out there have started offering managed accounts to Forex traders. This new breed of account is particularly useful to foreign exchange novices. It takes a good deal of time to get acquainted with all the intricacies of Forex trading even if you have unrestricted access to various educational materials and free training courses.
Becoming a consistently profitable trader takes tons of effort and preparation or else failure is imminent. With managed accounts, traders get the chance to indirectly partake in the foreign exchange markets much like they would on the stock market via mutual funds.
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You employ a market professional who uses your balance to execute trades on your behalf in exchange for a predetermined fee. This next article explains how managed accounts work and their key features. We also dabble into the subject of who should use a managed account and who should refrain from opening one.
Managed Forex Accounts – What Are They?
Unlike standard accounts, where traders themselves actively open and close their positions, managed Forex accounts are operated by experienced individuals who buy and sell Forex pairs on behalf of others. This account type is associated with greater costs because account managers charge extra fees for their services. The fees may vary a lot depending on where you trade.
Of course, you first need to open a live account with a reliable brokerage and transfer the necessary amount of capital to its balance. It should be noted that the managers are not in full control of the accounts they handle. Their access to the accounts is, in fact, limited.
It is the trader who controls aspects like withdrawal requests and depositing. Upon creating one such account, the trader and their manager are required to sign the so-called Limited Power of Attorney (LPOA) agreement, which ensures high levels of safety and transparency for the trader.
With this legal document, the two parties involved agree the manager can conduct trades on behalf of the account holder without the capability to deposit or withdraw from their balance. Once the LPOA is signed, the managed account is moved to what is known as a “master block”.
The actual account holder has the ability to review its balance, deposit, withdraw, and monitor all trading activities that take place there. The trader is entitled to cancel the LPOA whenever they want. It is impossible for them to execute trades on the managed account unless they cancel the above-mentioned agreement.
Most beginner traders typically leave signal and strategy decisions to their managers. However, if you are more experienced and already have a specific strategy in mind, you can always instruct your personal manager to implement it.
Another important thing to keep in mind is most managers typically have specific requirements about time and deposit minimums. If you request an early withdrawal, they might even penalize you with additional charges. In this vein, we should also point out managed accounts usually require significantly higher minimum deposits compared to standard trading accounts.
It is absolutely obligatory to ensure the person you choose as your account manager has considerable expertise and a good track record before you let them trade on your behalf. Go through the steps below before you set up a managed Forex account:
- Ensure the risk level of your chosen account and manager corresponds to your individual risk tolerance.
- Check out the fees and costs associated with running the managed account along with the requirements on minimum deposits. The charges can vary wildly across different brokerages, types of managed accounts, and risk levels.
The high water mark also bears consideration. This is a monthly fee charged on managed accounts whose net balance has exceeded a specific, predetermined percentage. Depending on the brokerage, you might also have to pay an account management fee or an account termination fee.
- The third thing you must factor in is whether your chosen broker provides past-performance history for the managed account. If yes, it should date back to several years.
There is a common misconception that managed accounts ensure guaranteed profits. This is untrue because of the volatility inherent to the Forex markets. All reputable brokers that support managed accounts post disclaimers to warn customers about the possibility of incurring losses.
Types of Managed Account
Managed accounts, also known as slave accounts, are divided into several main groups, each one having its own peculiarities and features. Brokers that cater to customers with such services usually offer individual or pooled accounts (MAM, LAMM or PAMM). These sound a little intimidating to Forex beginners so let’s have a look at their main differences.
Individually Managed Accounts
Individual accounts comprise the most basic and simple category of managed accounts. This is a fully segregated account in which your money manager executes trades on your behalf and follows all your instructions. The manager’s trading decisions depend on your individual risk tolerance and the strategies you map out for them.
The minimum required deposit amount for an individually managed account is often quite high because the funds in the balance are not shared between multiple investors as is the case with pooled accounts. Customarily, you need to start with an investment of at least $10,000 to open one such account.
It is very important to choose a highly skilled and competent manager since deposits are obviously rather high and all the trades are handled individually for you. Do your research and check other customers’ testimonials before you make your pick.
Pooled Managed Accounts
This type of account operates similarly to the way mutual funds work. As the name itself implies, the funds of multiple individual investors are pooled together into the same managed account. Respectively, each investor who contributes to the pool may have a different level of risk tolerance, trading strategy, and portfolio of currencies. Fees and costs may also vary between different traders.
Similarly to choosing an individual account, you need to do your homework before you decide which pool is best suited to your needs. Obviously, the main difference here is that the same account manager handles the trades of multiple investors.
To determine which pool to join, you must research how different funds have performed over the past several years. The minimum deposit amount is typically lower ($2,000 or less in some cases) because many different people invest into the same pool.
Percent Allocation Management Module (PAMM) Accounts
This is a subtype of pooled accounts that uses percent allocation money management. Alpari was the first brokerage firm to launch this type of service back in 2008. One and the same manager executes trades on behalf of multiple investors. This enables him or her to work with larger volumes and potentially achieve bigger returns.
One professional can simultaneously manage the trading activities of an unlimited number of investors. With PAMM accounts, the positions, profits, and losses of the manager are allocated between the different portfolios they handle.
Each trader’s account has an individual PAMM ratio based on the amount they have deposited, hence the name “percent allocation money management module”. The risk is distributed between the portfolios of all traders involved in the module.
Each participant can monitor the trading activities of the PAMM manager in real-time. This bolsters confidence and gives investors a greater sense of control. Of course, the money manager charges a percentage-based fee outlined in the LPOA agreement.
Below is an example of how PAMM accounts work. We have a single manager who works with three individual investors and charges a 10% fee for their services. The total pool contains investments to the amount of $20,000, which is distributed between the four parties involved as follows:
- The trader, i.e. the account manager, pours 40% into the fund or $8,000.
- Investor A accounts for 20% of the pool’s value or $4,000
- Investor B has provided 30% of the funds or $6,000
- Investor C has invested 10% into the fund or $2,000
Suppose that after one month, the trader who manages the account boosts the pool’s initial capital to $28,000, which corresponds to a 40% increase. The manager would then apply their 10% fee on the net earnings, i.e. $800. The remaining earnings of $7,200 will be distributed between all four parties like so:
- The trader/account manager collects $7,200 x 40% = $2,880 in net profit
- Investor A pockets $7,200 x 20% = $1,440 in net profit
- Investor B gets $7,200 x 30% = $2,160 in net profit
- Investor C receives $7,200 x 10% = $720 in net profit
Since the manager has also contributed some capital to the pool, they are less likely to act unfair toward investors or be sloppy with their money. Of course, no matter how thorough the manager is in their work, there is always the possibility of them sustaining losses during a given trading term. If this happens, they would obviously not charge their 10%.
Suppose the manager loses 10% of the account’s capital during the next month. The $28,000 pool would then drop by $2,800 to $25,200. Respectively, the individual investment of each pool participant would also decrease by 10%.
Lot Allocation Management Module (LAMM) Accounts
LAMM accounts are considered the predecessors of PAMM accounts. They function in similarly with one key difference – here investors determine the number of lots traded on the market. Their gains and losses correspond to the multiples of currency lots they have invested.
Respectively, if the trader who manages the trades purchases one standard lot, the account of each investor will also increase by a single standard lot. The size of the investors’ accounts is irrelevant in this case.
Of course, this typically works when the managing trader and the investors have assets that are relatively the same in size. LAMM accounts are mostly suitable for people who trade with significant volumes of capital.
Percentage allocation has little to no significance in this case. Liquidity could be an issue for investors who operate with such huge amounts of money. Sometimes, it is impossible to fill their orders in full at the current market price when there is not enough liquidity in the respective market.
Other than that, LAMM is pretty much a copy trading system. The trader who manages the LAMM account requires the investors to pay a fee. Both the investors and the manager use their individual funds for trading.
The positions the manager opens in the parent account are copied and executed in the sub-accounts of the investors who follow them. The followers can keep track of all trading activities in real-time. Each investor can determine their individual copying ratio to manage risk.
Multi-Account Management (MAM) Accounts
As its name suggests, a MAM account controls multiple sub-accounts. The account manager has the ability to increase the leverage on individual sub-accounts when investors instruct them to do so. Respectively, risk levels can also be adjusted separately. The manager is also capable of determining how many lots are traded by each sub-account.
As a general rule, this type of managed account is best suited to the needs of traders with higher-risk tolerance and a more adequate level of market understanding. Similarly to the PAMM account, here the gains and losses are settled at the end of the trading period under the terms of the agreement investors have signed with their MAM manager.
MAM accounts offer a variety of useful features. Positions are opened instantly on all sub-accounts. Investors have the chance to see comprehensive statistics on the executed trades along with a detailed transaction history. They can also monitor the commissions and the manager’s performance in real-time.
Key Features of a Good Forex Managed Account
Now that we have introduced you to the main types of managed accounts, let’s see what features you should consider before you sign up for one. First and foremost, you should register with a reliable and properly regulated brokerage firm that ensures fairness and a transparent environment to managed account holders.
The second thing you should factor in is the track record of your chosen account manager. The person should demonstrate consistent overall profitability. Choosing a manager with a low maximum drawdown level is always a must.
The Importance of Low Maximum Drawdown when Trading with a Managed Account
The drawdown is important because it indicates the amount of capital the manager has lost to unsuccessful trades. Suppose a person starts to trade with a balance of $50,000. After an unsuccessful trade, their equity drops to $42,000, which is to say their account has suffered a drawdown of $8,000.
In the context of trading with a managed account, the manager’s drawdown reflects the difference between the highest point of the account’s balance and its next lowest point. The drawdown is calculated by subtracting their equity’s low net value from its high net value and then dividing the result by the equity’s high net value.
Here is a simple example so you can better understand it. Let’s suppose you start with a balance of $20,000. It then skyrockets to $40,000, drops to $15,000, increases to $30,000, again drops to $12,000, and finally increases to $42,000.
In this case, your equity’s highest net value is obviously $42,000 while its lowest net value is $12,000. Respectively, your maximum drawdown equals ($42,000 – $12,000) / $42,000, or 71.4%. Keep in mind this is considered a high drawdown percentage.
Such massive slumps and upturns in one’s equity usually result from high-risk trading decisions. Lower maximum drawdown, on the other hand, can indicate less volatile investments. It is recommended to compare the account statements of different managers so you can pick the one with the lowest maximum drawdown. The statements should span a longer period, usually between three to five years.
Apart from the manager’s overall profitability and drawdown, your choice should be based on several other factors, including the trading system the manager uses, whether they deal with derivatives, the signals they rely on, and what software they trade with. Below we post a list of some good Forex brokers that accept managed Forex trading so you can choose one.
Reasons to Invest in a Managed Forex Account
Some of you are probably wondering why someone would let another person manage their capital for them. Well, there are several valid reasons why people choose to invest in managed Forex accounts. If you open a managed account with a reputable brokerage, you will benefit from high levels of security, transparency, and regulatory control.
This is the ideal solution for beginner traders who are not confident enough in their trading skills and knowledge of the markets. Managed Forex accounts enable them to generate healthy profits over a short period.
It is always a better idea to entrust a successful trading professional with your funds rather than opening and closing your positions on hunches. A skilled manager can help you improve your learning curve through adequate guidance and advice. Sure, the person will charge you for the service but you must not forget you are paying for their competence and extensive experience as well as for their time and efforts.
Plus, a trader can always cancel their LPOA if they feel they have gained sufficient experience to confidently trade the markets on their own. Then again, some people are interested in investing in Forex but have no time to spare for trading. Using the services of a good account manager will inevitably help them generate some earnings on the side.
Who Should Use a Managed Forex Account?
Setting up a managed Forex account is a great solution for traders who meet the criteria we cover in brief below:
- People who lack sufficient time to observe and trade the markets on their own. Traders who have full-time jobs cannot afford to spare enough time to watch price movements but success in Forex requires a full commitment. Managed accounts enable such people to pursue their conventional jobs while at the same time earning something extra on the side.
- People who lack sufficient experience are also recommended to give managed accounts a test drive. Forex trading requires knowledge and experience. In their absence, traders are doomed to failure. You are better off in the hands of a skilled manager who knows the markets inside and out rather than trading on intuition. Once you build enough experience, you can revoke your LPOA agreement and start executing trades on your own.
- People who are psychologically unfit to trade. Some traders are simply incapable of keeping their emotions at bay. It is common for such people to desperately hold onto positions that are clear losers. Others consider Forex trading very exciting and have a predisposition to overtrade, which is just bad.
If you recognize one of those two qualities in yourself, you better off leave a professional trader to manage your positions.
Who Should Refrain from Opening a Managed Forex Account?
As appealing as it seems to have someone else making decisions for you, managed Forex accounts are not for everyone. Carefully read the points below and refrain from setting up a managed account if you cover one or more of them.
- People who have insufficient capital. As we already explained, managed accounts are associated with higher costs. You have to pay a commission to the person who trades on your behalf, not to mention minimum deposits here are significantly larger than those for standard Forex accounts.
- People who insist on retaining full control over their trades. While it is always possible to instruct your manager what signals and strategies they should follow, managed account holders typically have little control over their trading activities.
- People who are unwilling to go through the process of setting up a managed account. We already talked about how one needs to sign an LPOA agreement with a manager before they can open this type of account. In essence, this is a legal document that serves as proof the manager is authorized by the account holder to trade on their behalf. This might be quite a time-consuming process.
- People who lack enough time to conduct proper research on different account managers. With such a broad choice of managers, it is highly recommended for one to check and compare the track records and performance of as many professionals as possible before they make a pick. Otherwise, you risk ending up with a person with a high maximum drawdown and insufficient enough experience. This would ultimately cost you money.