What should an investor choose: PAMM accounts or social trading?
PAMM accounts and social trading are 2 similar models of passive investment that may be interesting for both beginners and those who have little time or some interesting strategies. However, the PAMM model has its drawbacks that can result in serious investment risks. Bright examples: MMSIC, Panteon Finance, or ForexTrend. The social trading model excludes most risks associated with PAMM accounts, creating a transparent platform for a full analysis of strategies. The advantages and disadvantages of PAMM accounts and trader selection criteria are explained in this review.
PAMM accounts or social trading?
A new type of passive investment has been growing popular for the past 2 years - we are talking of social trading that has replaced PAMM accounts. These 2 ideas have a lot in common. For example, a trader acts more as an investor in both cases since he/she doesn't take a direct part in trading. They still differ in some essential aspects. First and foremost, we mean risk diversification, transparency and managers' responsibility.
Read on for more information on PAMM accounts and social trading, their advantages and disadvantages and on how they work. First, let's mention those for whom these systems will be interesting:
- those who have spare money but don't have time for trading actively;
- those who want to diversify risks, investing money in different traders working with varied assets or strategies;
- those who don't know much about trading and prefer to confide in professional traders;
- professional traders who wish to attract investors for increasing trading volumes.
What is a PAMM account and how does it work?
PAMM (Percent Allocation Management Module) evenly distributes a manager's profit, less management fees, among investors based on their share in a total investment. In other words, investors entrust their money to a manager who uses it at his/her discretion in the best interests of the investors. It resembles in part an asset investment system, but PAMM is much more attractive.
How it works
Every manager can open a few PAMM accounts depending on a strategy applied. An investor opens an account with a broker, gets familiarized with the terms of the offer and transfers money to a manager's PAMM account (press the "Invest" button in a portfolio invested, specifying a transfer amount) and then follows trading statistics in the personal profile.
Example. Let's say an investor pays $1,000, manager's fee is 40%, manager's personal deposit is $1,000, and final profitability is 5%. Profit amounts to $100 (5% of $2,000). Before it's distributed, Investor's profit amounts to 50% (according to his/her investment share in the overall portfolio), but then he/she pays 40% of it. In the end, an investor's net profit equals 100/2 * 0.6 = 30 usd.
Advantages of PAMM accounts as compared with asset investment:
- Investments in PAMM accounts are made automatically, profits are distributed automatically as well. An investor can see a manager's offer wherever in the world. Topping up an account with a broker is enough. Concluding a contract with an asset management company and paying money is way more complicated and longer.
- PAMM's relative transparency. An investor can see a deposit curve and a manager's back test statistics. He/she can specify a character of a strategy used in a personal conversation and take his/her money back at any time (if the offer provides for it). The same information is often unavailable at asset management companies.
- Risk diversification. An investor chooses as many managers as he/she wants and allocates money the way he/she wants.
- Tax saving. A management company deducts taxes from profits in any case. A broker, unless it's a tax agent, transfers tax responsibility to an investor. The latter is not really willing to share profits with the state, working with e-wallets.
Disadvantages of PAMM accounts:
- Relatively big manager's fee. Most often, 20-50% of profits;
- high risks. As an example of Zulutrade has shown, most managers use Martingale and averaging practices. Or, even worse, they may be false accounts of dishonest brokers;
- complicated money withdrawals. In most cases, an offer provides for an early withdrawal fee (a fee for withdrawing money before a rollover takes place and profits are distributed);
- no opportunity to influence directly a trading course.
When PAMM accounts were all the rage, there appeared fully-fledged broker platforms dedicated to asset management services. Once the investors in such giants of the Forex market as MMSIC, Panteon Finance, and ForexTrend lost their money in full, the popularity of PAMM accounts somewhat cooled down. Initially, those platforms offered an interesting system of PAMM accounts where risks were halved between an investor and a manager, though such conditions were not beneficial to a manager as a matter of principle. However, investors were impressed, just like organisers wanted. In reality, those platforms turned out to be nothing but financial pyramids and the question "Did PAMM managers really exist" is still rhetoric.
Investors could no longer confide in PAMM accounts. So a new trading model appeared - Social Trading.
What is social trading and how does it work?
Social Trading means trading by use of a professional trader's strategy with one essential difference: an investor does not make money transfers. He/she subscribes to a trader and then copy trading begins. In other words, any position opened and closed by a professional trader is opened and closed in an investor's account. Every client of a broker can be both an investor and a trader at the same time.
- all traders are the broker's clients. Trades are copied instantly as they are all conducted on the broker's servers. Delays and slippages are excluded (trading is done only in ECN accounts);
- a broker offers 4 copy trading options. Copying can be done with a full or a fixed size, with a predefined % of each trade or a fixed share of an investor's funds;
- a broker is an intermediary between an investor and a trader, earning solely from spreads and standing surety for the both parties, without charging any commissions. A broker cannot access traders' and investors' personal accounts. The history of trades is recorded on the server and cannot be modified.
How it works
A social trading platform provides for every option to protect investors' interests. Every trader has his/her investor password that excludes broker's intervention in his/her trading. Prior to subscription, an investor can get the trader's investor password in the live chat and ask any questions concerning the strategy. In his/her turn, a trader is interested in keeping a good reputation: the more investors he/she attracts, the more commission he/she will earn.
- Remember: the PAMM model means a manager can fully dispose of investors' money. There are real examples of platforms asking a manager to blow an investor's deposit for a monetary reward. Otherwise, the manager could risk his/her account. In Social trading, a trader earns a commission for profitable trades and values his/her reputation. An investor can get detached from a manager at any time, which is impossible under the PAMM model.
Before starting to copy trades, you need to estimate risks, potential profits, margin amount, and so on. Use a Forex calculator not to get stopped out before a trader.
Advantages of Social trading:
- the whole of information on a trader's trades is in free access, including a short description of his/her strategy and the history of trades opening. An investor can put all the questions to the trader in person;
- an investor's money is kept in his/her account and he/she can disconnect from the trader at any moment if the latter is suspected of trying to blow the deposit;
- an opportunity to limit risks, setting "a copy stop level";
- an investor can influence a trading process, applying his/her own stop loss levels to the trader's strategy, closing an open trade earlier, changing a volume, etc. I.e, an investor can manage risks under his/her own risk management system;
- there's an opportunity to chat with the trader in a real time mode. There's also a news feed where an investor can see the trader's current results and trading discussions.
An investor can make a choice based on fully open data. The manager and his/her strategy are assessed by investors themselves.
How to choose a trader for copy trading:
- check his/her account's lifespan and the number of opened/closed accounts. Accounts are usually closed for better statistics, so too many accounts closed are a bad tendency. Account age: at least 6 months;
- analyse average annual and monthly profitability and profit for the past month. Check the behaviour of a deposit curve in crucial moments of the past year;
- assess maximal drawdown and profit in the accounts as expressed in % of a deposit;
- don't seek after the best traders. Instead, invest in those who offer the lowest risks. Higher profitability is associated with higher risks;
- pay attention to most people's opinion: the more subscribers a trader has, the better. The amount of a trader's own share and reinvestment is also important (it should be at least 10% of investors' capital). All this can be seen in a trader's statistics.
Remember that a good choice of a trader doesn't guarantee 100% profit. We don't recommend that you invest in scalping where even fractions of a second matter. Try to ensure that the conditions in your account are as close to the trader's conditions as possible: we mean leverage, deposit ratios, and so on.
So, what to choose: PAMM accounts or social trading? Social trading, of course. This model is more transparent than PAMM. But the most important thing in social trading is that a manager (a trader) is not tempted to blow an investor's money. And what would you choose?
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The content of this article reflects the author’s opinion and does not necessarily reflect the official position of LiteForex. The material published on this page is provided for informational purposes only and should not be considered as the provision of investment advice for the purposes of Directive 2004/39/EC.