When we put pen to paper, usually it’s to explain some principle that can help traders progress towards consistency. In some ways, it seems that the end game is consistency. It’s not. In reality, the actual career of a trader starts when consistency is achieved. 

In this article we are going to explain what comes next: the pathway to becoming a professional money manager. A current CTA manager I’m in touch with once said “this job is simply too stressful if you’re going to make a normal salary“.  Stated differently, the opportunity cost is too high, unless you actually make the most out of your trading endeavours.

For all of our members currently on their path to consistency, for the coaching members that are working on their track records, and for those readers that are just curious, here is what separates the future earners from the constant learners.

No Demo Trading Allowed

This sounds silly but in reality I have received track records that didn’t look half bad..if not for the fact they were done on a demo account!

But I can’t cast the first stone: my own mindset was completely off course when I started. I thought that the most important thing was to build a method. Then, after successfully demo trading it for 3-6 months (being disciplined and recording the account statistics) the transition to a live account should have been seamless.

Unfortunately it wasn’t so easy. And for many people, this transition from demo to live is a real challenge. Whether it’s  because of fear, or lack of capitalization, or some other mental issue, when hard-earned cash is on the line, most good habits get thrown out of the window.

In order to obtain funding, you will need a track record from a real account, that you have been trading for at least 18-24 months.

Independent Monitoring

When you start your track record, be sure to attach it to an independent analytical tool. This accomplishes two things:

  • it saves you time, so you can concentrate on executing your plan
  • it allows the funding partners to sift through whichever details of your trading they desire
  • it allows you to prove you personally traded the account

Along with these quantitative measures, you will also need to provide a description of your approach. For example, you would need to explain:

  • What is your defined trading strategy? (typically a systematic strategy, even if not 100% mecchanical, is preferred over discretionary strategies and even 100% algo strategies)
  • How do you stack up against that competition?
  • What is your edge?
  • Who is your target investor audience?

Luck or Skill?

All of the requirements listed above are the due diligence performed by funding partners, to assess how skilled the trader is. A 2-year track record doesn’t actually mean the trader will continue to perform in the same way. The strategy might have inherent capacity limits (and this is especially true of short-term strategies and/or scalping strategies); the strategy might be arbitraged away; the trader’s psyche might be influenced by the amount of capital allocated; the trader’s discipline might go downhill…so what are some objective measures that can help a funding partner obtain some kind of forward-looking expectation?

Return Quality: the first thing to understand is that absolute P&L doesn’t matter. The distribution of profits & losses in percentage terms is better (because it renders the account size irrelevant). Below is an example of a random probability distribution of returns.

The first thing to assess is whether the mean of the distribution (sum of all returns/number of trades) is positive or negative, within a certain confidence interval. In our example, the mean is slightly positive but there are also a fair share of negative returns.

The second thing to do is to remove the outliers. Some performance records look great in %-terms, when in fact almost all of the performance was due to 1 or 2 trades. By removing the outliers (which in very simplistic terms are the returns that evidently deviate from the mean) you obtain a better representation of the average performance metrics.

In the example below, we have a clear outlier that requires removing: a giant leap forward in one go, near the beginning of the trader’s track record. The account suddenly shoots up from 10K to 20k. This is a red flag, especially because the ensuing performance was approximately breakeven.

There has been either a trade of abnormal size, or a deposit to the account, but in any case it’s strange and needs to be eliminated from the return distribution. This trader would not pass the initial phases of the screening.

Another way to check the quality of returns is to apply a simple Garch (1,1) to the distribution of returns. Essentially this will capture the average return, compensating for return volatility.  The Garch (1,1) will answer the question: is the average return statistically  significant, and higher than 0? I used this method for my university dissertation, applying it to mecchanically derived trading signals from the most common technical indicators. Some of the trading signals did produce a positive return over time, but the equity curve (under the Garch analysis) was not robust enough to contain any “skill”.

Risk Assessment: to understand the reasoning behind proper risk assessment, let’s use the case of a trader that – if evaluated on % profit alone – looks like he found the Holy Grail:

In the chart above, the red line represents consolidated equity (i.e. closed position equity), and the yellow line represents current (or open-trade equity).  When I see traders with a strong consolidated equity, but a weak open-trade equity, it raises a huge red flag. It means that traders are holding onto losing trades and only closing winning trades.

The chart below illustrates the ever-increasing drawdown that this trader is accumulating. Serious investors do not care about absolute performance. They care about risk-adjusted performance. If a trader has a 50% MaxDD, it really doesn’t matter if he makes 100% return in a year. Investors would certainly prefer a trader that has a MaxDD of 2% and a performance of 4% per year. Same risk:reward, totally different impact on portfolio and psyche.

Generally speaking, Sam & I recommend that traders maintain their drawdowns below 5% per month, and attempt to make at least the same amount on the upside. And that’s for retail-level account balances (USD 1000-25.000. For larger accounts, a monthly drawdown of 2-3% is a good measure.

Make no mistake: you will never obtain funding by holding onto losing positions like this, let alone running a 75% MaxDD! Nowadays traders are monitored in real time and funding partners assess the Current Value at Risk  (which, as a rule of thumb is the largest loss – consolidated or not – which occurred in the last 20 trading days). This will weed out traders that hold onto losses whilst closing winners quickly. The historical Value at Risk would look excellent because it can’t keep track of the equity swings during the day. Current Value at Risk can do this, and it can detect for example

  • traders that use martingale strategies
  • traders that average down (i.e. dollar cost averaging strategies)

On top of the Current VaR, funding partners also like to establish what the consistency of returns is. Essentially, this is done by taking  (average win/average loss) over a given time period, and verifying whether there are significant changes from one month to the next, from one quarter to the next or from one year to the next.  Consistency, as Sam & I often state, is key.

The Trader’s Personal Situation

Be prepared to describe your personal situation as well. Investors prefer to see stable personalities and stable lives, more than volatile personalities and volatile lives. Be prepared to answer the following questions:

  • What is your current daily routine?
  • If your income were doubled or tripled, what would your routine look like?
  • Do you see yourself as a full-time trader or as a part-time trader?
  • Are you conducting your life towards that goal?
  • Have you ever run your own business? Are you aware of the commitments that are necessary in terms of time, capital and stress?
  • Do you have a contingency plan?

Congratulations, You Are Qualified

So just to recap:

  • You have been trading a live account, larger than USD 10.000, for 18-24 months
  • You are consistent and profitable
  • Your drawdowns are contained
  • Your personal situation is in order
  • You have a 2 page document which contains your bio, a short description of your method, and the main historical statistics.

At this point your historical performance makes you a viable candidate for live screening. Typically this is the stage where you are required to open and trade a live account whilst under constant scrutiny on behalf of the investors. This is where the Current VaR & similar real-time measures come into play.

To be realistic, if your real-time performance continues to mirror your historical performance, serious investors will have starting allocations of USD 100.000 to 250.000. You get more bang for your buck, and you start to grow from there. It is entirely achievable to reach USD 1MLN+ AuM with the right people.

Over to You

There are many career paths for talented traders, but going down the funding route – with proper investors – is the route that gives you the most bang for your buck. Moreso even than prop shops. Prop shops are all about churning accounts through intraday or high frequency trading. It’s very rare for a prop shop to allow lower frequency trading. Funding allows you to work your edge, without that kind of pressure.

So the first step of course, is to reach consistency. At FXRenew we attempt to do this in two ways: through our flagship Forex System Development Workshop and through private Coaching sessions.

Then, start building your track record and get in touch! Sam & I are always available to offer detailed feedback on your current performance, because our greatest achievment is to send qualified members towards our funding partners.

Good Luck!

About the Author

Justin Paolini is a Forex trader and Coach. He is co-owner of www.fxrenew.com, a provider of Forex signals from ex-bank and hedge fund traders (get a free trial), or get FREE access to the Advanced Forex Course for Smart Traders. If you like his writing you can subscribe to the newsletter for free.conso