In this post, I will explain how you can ensure that you select a reliable trader with a credible track record of performance.
This will help you invest with genuine traders that really have made money and that operate a legitimate business.
We will be looking at the following topics:
- Why you should invest a portion of your capital with a good trader
- Some minimum requirements you must always demand
- Some common tricks and scams you need to avoid
Working with a profitable trader can yield returns not generally found elsewhere. There is always more risk involved but if you find the right balance it can be a great investment.
One of the first lessons to understand is that risk and reward are always inextricably linked. Investopedia created a guide on something called the risk pyramid in 2018.
The concept behind the risk pyramid is to help investors like you identify how much risk is involved in different types of assets.
For example, the lowest risk asset to invest into, according to the risk pyramid, is cash and cash equivalents.
One of the riskiest assets is futures trading which is closely related to spot FX trading. The very first thing to accept, as an investor, is that there will always be risk.
The general rule of thumb is that you should expect to lose roughly the same amount that you expect to earn.
If someone is promising you 30% per year then you would be reasonable to expect 30% drawdowns in the same year.
This is a major reason why promises of huge returns with low risk are a red flag in the first instance. No credible fund manager would ever make such claims.
Benefits Of Working With A Professional Trader
Many investors commonly view high risk and unacceptable. The key is to have some kind of balanced approach.
Having an account managed by a professional FX trader can be extremely rewarding if conducted in the correct way.
For example, the percentage of your assets invested into FX should always be within a range that you can comfortably lose.
Of course, no one truly finds losing money comfortable but the main thing is that it doesn’t leave you awake at night worrying.
You could identify a percentage of your investment assets or you could simply dictate a fixed cash amount that you are happy risking.
This amount will change according to factors such as your age, personality type and the reasons for investing in the first place.
It is also important to bear in mind that there is also risk in doing nothing with your cash. In the UK, inflation averaged 2.58% per year in between 1989 and 2018.
This inflation erodes your purchasing power and makes your money worth less and less as time goes by. This is the main reason for having an investment strategy in the first place.
A credible FX trader can help you mitigate these risks while also giving you a good chance of achieving a higher return.
They will trade the markets while keeping a keen eye on their risk management. Crucially, they will have already experienced every type of scenario.
This makes them fully prepared for anything the markets can throw at them.
Finding such traders is notoriously difficult so we will now look at several requirements that you must demand.
Ensuring that these things are in place will protect your money and will increase your chances of having a successful FX investment experience.
Importance Of Performance Verification
The number one requirement when vetting a trader is that they have a fully verified performance track record.
In order to trust a track record you must understand how all of the verification methods actually work. This will help you determine how much trust to place in it.
There are generally three levels of trade performance verification.
The lowest level is when the record has an element of third party verification but can also be influenced by the trader themselves.
An example of low quality verification could be a copy or screenshot of their brokerage statements. This is derived from the broker but can also be easily manipulated.
Other examples of low quality verification include things like online tracking sites that plug into trading accounts. These can also be manipulated fairly easily.
Mid-level verification often comes in the form of an official letter from a credible third party. For example, an accountant or even an administrator can verify trading returns.
These are often called letters of opinion or verification letters.
The checks that form a letter of opinion are slightly more robust than low level verification but still open to manipulation.
Checks are usually carried out on the trading account itself. This avoids outright trader manipulation but it can miss more subtle things.
The highest level of verification is a full trading account audit. This is where a larger firm (usually top 10) will fully investigate performance and attempt to weed out any false information.
An audit will check each trade and trace it all the way back to the liquidity provider that the trade was processed through.
It will request information from the broker and custodian banks to ensure that all transactions match up perfectly.
It will also investigate power of attorney agreements and details of account activity.
Working With Regulated Traders
Another crucial feature of a credible fund manager or trader is regulation.
Generally speaking, in order to trade client money a trader must be regulated in the jurisdiction that they physically live in.
A common trick of unscrupulous traders is to set up a company in a low quality regulatory jurisdiction and then operate through that.
This allows a trader to operate freely without recourse. For example, St Vincent and the Grenadines has a regulatory body but they do not cover FX trading.
This leaves you with no protection in the event that the trader operates recklessly or even fraudulently with your money.
This is especially true for managed account programmes. Hedge funds will very often be directly regulated and this should also be investigated.
To fully protect yourself it is advisable to only work with traders that are regulated in a credible jurisdiction.
Places such as Canada, the US, EU, UK, and Australia are reliable choices. Smaller nations or developing economies pose the biggest risk.
Once you have found a trader that is regulated correctly you then need to double check with the regulating body that they’re registered.
Another tactic used to deceive investors is that of simply claiming to be regulated when in reality they are not.
It’s also worth mentioning the importance of checking that the trader has the correct permissions.
A trader may be registered with a regulator but not have the specific permission to manage clients’ money.
There are many different types of regulatory coverage. It is very important that you conduct thorough due diligence in all of these areas.
A Quality Broker Is Also Important
The same due diligence should also be carried out on the broker that the trader is working with.
It is remarkably common for traders and brokers to form relationships that present a conflict of interest with you the investor.
For example, the trader could be paid commissions directly from the broker based on trading volume rather than profits.
In that scenario, the broker wins from the extra business and the trader wins from the guaranteed income they receive.
You are extremely vulnerable in this scenario to your account being eaten away by fees and commissions.
To avoid this, the same regulatory checks apply to the broker. Take your time to thoroughly research the broker and their regulatory status.
Regulation doesn’t guarantee that you won’t fall victim to fraud but it does ensure that there will be some recourse if it happens.
You should also read thoroughly the power of attorney agreement between you and the trader.
Contact the broker directly and specifically request all information relating to the relationship and fee structure between them and the trader.
These documents will help you understand exactly how the trader gets paid and where their true motivation lies.
Anything based on commissions is a huge red flag. Any kind of hidden fee is unacceptable.
A legitimate fund manager will make money through performance fees and transparent management fees only.
Common Scams Involving Funds
Having an online education business for retail traders has given me access to countless horror stories over the years.
The most common scam is when some trader offers you to invest into their fund. You, the investor, then transfers some money over to them for them to start trading it.
The term fund is banded about so frequently that it is difficult for many investors to understand what it means.
Inevitably, things goes wrong and your money disappears one way or the other with no trace of what really happened to it.
The goal of the scam is simply to part you from your money.
To protect yourself from this happening you need to understand what a fund actually is. This will allow you to recognise when a so called fund is actually a scam.
A true fund is very similar to a corporate structure. This means that there are certain parts to it that must be present in order to be called a fund.
The most integral part is the fund administrator. This is a third party company or person that acts as a middle man between the trader and your money.
If it really is a fund then your money will be transferred to the bank account in the name of the fund, not the trader.
The trading account will also be held in the name of the fund rather than the trader.
When setting up your investment you will deal directly with the administrator rather than the trader.
They will send you the offering documents or informational memorandum for the fund in question. The administrator should be registered with the regulatory body in which they operate.
If there is no administrator then it is not a fund. Avoid transferring money to anything other than a true fund.
The Managed Account Scam
While some traders will try and present themselves as a fund others will operate under the banner of managed accounts.
This is more dangerous because it seems so safe on the surface. Managed accounts allow you, the investor, to keep your money in your own brokerage account.
As discussed earlier, this can result in huge losses if the broker and the trader have kick back agreements in place, out of sight.
The goal of this scam is to trade your money to death and profit from the commissions that this generates.
Your account balance gets eroded away and the trader can simply say it was lost in the market. The broker then pays the trader a split of the losses. The trader then goes off to hunt new investors.
Aside from the measures we looked at earlier, you can also request hard lot size limits to be imposed on your account.
For example, if you have invested $100,000 you can request that the trader is unable trade using any more than 2 standard lots.
This drastically limits the leverage capability and will radically slow down any losses. If the trader is consistently losing you can see this and close the account.
If you do not limit leverage then large chunks of the account balance can be wiped out in just a few trades. This stops you from being able to react in time.
You can also invest a fraction at the beginning to see how the trader performs over a six month period. This still exposes a significant amount of money to losses however.
Scrutinising broker/trader relationships and fee agreements while placing hard limits on lot size are your best bet with this type of investment.
You can always lift these limits later when you the trader has proven themselves.
Fraudulent Trading Performance Records
Another hugely common tactic used to defraud investors is that of displaying false track records. If you know how these tricks operate then you can protect yourself from them.
Falsifying trading performance comes in a variety of creative forms.
The oldest trick in the book is one that I fell victim to myself at the very beginning of my own trading journey. This is when traders photo shop their broker statements.
On the face of it, a broker statement seems very compelling. In reality, it is so easy to manipulate that it should be completely discounted as proof of performance.
Another trick is when you are presented with a signed letter of opinion, usually from a broker. Very often these are simply fake.
As part of your due diligence you should verbally talk to the person who signed the letter at the brokerage or accounting firm in question.
Once you have ascertained that the person behind it is real, your next step is to fully scrutinise the company they work for.
If it’s a broker, are they regulated in a credible jurisdiction? What kind of reputation do they have online?
If it is a third party such as an accountant, how large is the organisation? Is it possible that they are close a friend of the trader in question?
Answering these questions will help you clarity the accuracy of the performance track record.
Another common tactic is to connect a profitable account to an online verification site. These claim to show trading performance that has not been manipulated.
To verify this type of performance record you need to request investor access to the brokerage account and watch the trading live.
If you do this over a period of three months you will quickly see the validity of the trader’s record.
The goal of this article is to provide you with information that you can use to protect yourself when investing with professional traders.
If you implement the advice here then you have a much better chance of detecting unsavoury traders that are intent on committing fraud.
Remember to thoroughly scrutinise both the track record and the brokerage that the trader works with before handing your money over.
Also, look in detail at how the trader will be compensated both from their trading and through the broker.
A fund is only a fund if it has a registered administrator that you can talk to and verify. Never transfer money directly to the trader themselves.
If you would like any assistance with verifying a particular trader or brokerage then please contact my support team today. They will be happy to assist you if they can.
If you have any further questions or comments about this article then please leave them below. I read every one and reply to as many as possible.