PAMM is a way for investors to put money to work by allocating a proportion of their account funds to other traders.
It’s similar to investing in a managed investment fund, however PAMM allocates capital directly to one or more independent traders on a percentage basis.
For the investor, it is passive. It doesn’t require any knowledge of trading, and there are no decisions to make other than which traders to allocate your money to.
What is a PAMM Account?
Brokers originally offered PAMM accounts to allow ordinary investors to access a range of trading strategies and products that were not available through mutual funds. The risks in PAMM can be much higher but so can be the rewards.
PAMM – or it’s full name Percentage Allocation Management Module – is appealing to some as an alternative way to invest. The reasons are not difficult to see. Poor returns from the stock and bond markets, coupled with ultra-low interest rates have seen investors looking elsewhere for better yields – beyond the traditional offerings.
Many online brokers now offer investors online PAMM accounts in one form or another.
You’ll achieve the same profits or bear the same losses as the trader you copy over the period you invest.
As well as PAMM, there are other copy trading services such as ZuluTrade and eToro – but these work in a slightly different way to traditional PAMM.
How PAMM Works
The way PAMM works is very straightforward. You decide how much you want to allocate, and to which traders. Once you’ve allocated that money, it’s added to the managing trader’s pot of capital. You’ll achieve the same profits – or bear the same losses as the trader – over the period you invest, on a percentage basis.
You don’t need to do anything else other than monitor what’s going on.
Let’s consider an example. Say you invest $100 in a trader, and say he or she makes a 25% profit in the first week. After the first week, your capital invested is now worth $125. Now suppose in the second week the trader makes a loss of 10%. Your capital now stands at $112.5.
Let’s say you decide to take profits and close the PAMM account with this trader. At this point, you need to pay the manager’s fee on your profits – suppose that’s 20%. Your final profit after 2 weeks would be 80% x $12.5 or $10.
PAMM Trader Selection – How To Choose
If you’re planning on using a PAMM system as an investor, your biggest challenge is choosing which traders to invest in. Keep in mind the rule that past performance is not a reliable guide to future returns.
If a trader hasn’t much of his own money at stake, he has little to lose if things go wrong.
That said, it is wise not to ignore this information completely. A trader’s track record and trading strategy is clearly something that needs to be weighed-up when considering risk and deciding where to allocate funds.
Most PAMM systems allows you to invest in any number of traders. So you can spread your risk over different strategies and managers. A word of warning though about diversification. Diversification of copy traders is not as simple as it first seems.
Many factors influence a trader’s performance. Strong correlations exist in the currency markets and it’s a fact that many traders, by habit, use similar tools and signals. Whether those tools are manual or automated. The returns of such traders will often “move in tandem” with one another.
This is why it’s important to do a diligent analysis of your chosen group of traders before investing real money. Performance history as well as other metrics can be viewed for all of managers partaking in the PAMM system.
A few things to pay careful attention to are:
- Manager’s capital – how much of the trader’s own funds are at risk
- Manager’s fee (remuneration) – the fee paid on any profits – ranges from 20%-75%
- Maximum relative drawdown – peak-to-trough decline as percentage of the fund’s capital
- Leverage – the leverage ratio the trader is using – higher ratio means more risky
- Current profit – the total accumulated profit achieved to date
- Daily profit – average daily profit that the manager achieves
- Daily profit volatility – the standard deviation or “variability” in daily profits
- Recovery factor – ratio of total profit to maximum drawdown (higher is better)
- Time running – the trader’s performance track record
Fees Don’t forget to check the manager’s fees. Sometimes this can be as high as 75%. If a trader is going to make a few thousand percent in profit over a year – which is not impossible when high leverage is used – then investors might not care about losing a big chunk of that on a management fee.
On the other hand, remember, the trader may have little to lose if things go wrong. Especially if he hasn’t much of his own money at stake. Because of the nature of PAMM it’s wise to be cautious of traders who’re investing very low amounts of their own capital.
Trade History Most of the PAMM managers choose to hide their trade and order history. So you don’t have any way to see which instruments are being traded nor the trader’s underlying strategy. That means you have to place a lot of faith in the performance data that’s provided.
Not being able to view trading activities is not necessarily a bad thing. While it takes away the ability of seeing trades as they happen, it also removes the temptation to “interfere” with the trading plan.
There’s a body of evidence that shows people who are too “hands-on” in their investment efforts on the whole achieve poorer returns than those who don’t interfere and are more passive.
Maximum relative drawdown This will give you an idea of how risky the trader’s strategy is. Deep drawdowns – of more than 50% of capital – indicate a risky strategy and possibly poor money management as well.
Keep in mind that drawdown metrics are not fool proof. Traders often change their behavior and strategies over time and for differing markets. Also note that if the fund hasn’t been running for long, this data won’t tell you very much in any case.
“Take Profit” and “Maximum Drawdown”
These are two important settings you’ll want to familiarize yourself with. Firstly, the “take profits” lets you automatically close a PAMM copy when a trader achieves a profit target set by you. This is a useful way of locking in profits.
It’s especially handy if you feel the trader’s success may be short lived. For example if he or she is using an aggressive short-term strategy.
The second thing to configure is the “maximum drawdown” setting. Setting a maximum drawdown will protect – as far as practical – your capital from uncontrolled loses suffered by the trader. If your maximum drawdown level is breached, your PAMM account on that trader will be automatically closed at that point. So limiting your losses.
Tip It is best to have a maximum drawdown setting. Unless of course you’re willing to allow a total loss on the amount you’re investing with a given trader in return for potentially higher profits.
It’s better to set the value cautiously to start with, and widen it as you watch the trader’s activities and he or she makes a profit for you.
If you’re investing a relatively large amount, it is wise not to set a big drawdown value for a PAMM trader, at least until they’ve proven themselves.
Warning Keep in mind if you set the drawdown limit too tight it could cause otherwise profitable trades to close out prematurely due to floating losses.
Why Use PAMM over Copy Trading?
PAMM has some advantages over regular copying platforms like ZuluTrade or other trade replication software.
1) The first advantage With PAMM the funds allocated by copiers becomes the “entire capital” of the trading account. This means there’s virtually no latency – or slippage when trading takes place. Trades aren’t replicated to followers but are executed once with the allocated capital from the investors.
The trader only has access to his own capital within the entire pool of funds – but his trade sizes are automatically “scaled-up” in exact proportion to the full amount that’s allocated to him by his copiers.
By contrast, what happens when you follow a trade signal say on ZuluTrade or through Meta Trader is that the trade is first executed remotely by the “supplying trader”. That trade instruction is then replicated a few instants later in your account. And because of that small delay, you’re unlikely to achieve the same entry or exit level as the trader you are following.
This latency is known as slippage. Cumulatively, slippage can cause significant reduction of performance. These amounts add-up over time and can severely cut into profits. It is not unknown for copy traders to make a loss even when the signal itself is profitable.
This is why it’s hard to replicate high-volume/small-profit strategies like forex scalping with a signal or through basic replicated copy trading.
The problem is worsened if you’re using an entirely different broker to the trader. Differences in spreads and quotes between brokers can mean you achieve overall a worse performance than the signal itself.
These slippage problems should not happen with PAMM, provided the system works.
2) The second advantage Traders are typically only compensated on profits achieved for their copiers (investors). So when you close your PAMM account with a trader, his or her remuneration is calculated on the amount of profit you’ve made – not on the trade volume as with many forex copying services.
PAMM can work better when investing larger amounts – because the trader’s earnings are better aligned with the interests of their investors.
If you exit with a loss, or with no profit at all, the trader does not make anything either – or at least no more than “roll-over profits” which they realized during the time frame you invested.
That’s one of the reasons PAMM can work better when investing larger amounts – because the trader’s earnings are better aligned with the interests of their investors.
Does PAMM Work As an Investment?
PAMM and other copy trading schemes can make profitable and exciting alternative investments. However choosing the right PAMM broker and which traders to invest in is key to making money over the long-run. Due diligence is necessary since these systems are essentially unregulated with no pre-screening of traders or strategies.
When new to this area, it’s also wise to start small and build up as you gain more confidence and experience. PAMM investments should be considered as a medium to high-risk. It should therefore only make-up a small portion of an overall portfolio.
PAMM accounts allow you to begin investing with amounts as low as $10 per trader. This makes it useful for investing a small pot of risk capital.