3.25 reasons to trade with investor funds
Any aspiring and developing trader will have a need for additional funds. There are many people working on automated trading strategies that lack the funds to fully trade them. In the last post we have looked at the negative sides of having investors as a trader. Yet, trading “OPM” – Other People’s Money – also has significant advantages. At NetTecture (that is the company behind Trade-Robots) we are actually right now considering “getting our act together” (making some nice websites, doing all the mumbo jumbo) and making some of our strategies available to third parties. Yes, there are a lot of negative sides to that – but trading with investors can have advantages, too. Our decision is not yet made…. But let us have a look at the positive sides.
If a person (or company) does some strategy development, it is generating a lot of ideas. A lot of things get validated. A lot of things are ready to trade. Trading them, though, can take significantly more capital than available. In our case we have a large “wall of paper profits”. That is a whiteboard – not a small one – where we pin strategies that are ready to be deployed, ready to enter the final state before getting allocated cash (which we call staging, to test whether they work like that in a simulator). This wall of paper profits right now has 60 ready strategies that are not getting real money allocated. Are they good? Likely ;) So why not money allocation? Because we do not have enough money. We trade what we consider the “mix of the best” with our trading account. And the account is not big enough to even satisfy the strategies that are in there to the limit.
If one is in this position, then any additional traded strategy is – less money than trading it yourself, but more money than can be achieved by not trading it. Yes, the split hurts the bottom line, compared to allocating your own funds. But it does not compared to not trading them at all. Definitely – trading investor money has the potential for additional income.
In addition, a lot of trading profits may be needed to offset the costs of the trader – likely a larger case for developers of automated trading strategies that require significant infrastructure. This means that for a smaller account the net profit – without costs – can be significantly reduced by costs. Additional income may be very welcome here.
Could we build up our account using profits from our own automated trading? Yes, we could. We could even just allocate additional funds. But it would be reckless. A trader that is slowly building up his account also has to build up external equity not allocated to trading – because trading should always be done with risk capital alone. A trader that has no money and trades aggressive loses little when he goes bust. A trader that has a million or two (USD, EUR, choose) and goes bust due to a market event lost life savings. He should not allocate more than a percentage of his funds to the trading account – which also means that the fund buildup will be slow, as most of the profits go into other investments.
Trading Investor funds means the risk is limited – as long as the trader follows the law and contract with the investors – but the trader can still earn a lot of income. Without allocating significant, reckless percentages of his personal wealth.
Trading Investor Funds can give a trader psychological help from a fear to lose his own money. All traders are different, and there are some that are afraid of losing their own money – but can safely trade other funds, and do so well. For those traders it may even be a good thing trade pretty much only investor funds. These traders exist. . If this sounds ridiculous – there are a lot of traders working for trading companies that risk little or token funds and work for a split of the profits that they get for trading the companies money. As trading is psychology – even automated, because one must be clear in mind to make the right decisions about risk allocation. Not every smart person (not every Quant) has the right setup to push through periods where strategies do not behave as expected, the market is not working right, if he has his own money on the line.
There is also the legal side. Trading investor funds makes some people more careful – and this may translate into larger market profits. The risk of legal actions when risk parameters are broken, the knowledge that it is a job and a contract has to be fulfilled, can help a trader control his own emotions. Yes, it may not work for every trader, but there are people where this can help.
This is a weak argument, so we only count it as a quarter of an argument. A lot depends on the negotiation power. In the past, Hedge Funds had a 2/20 rule, where fund managers got 2% management fees despite profits. Although this is rare for a pure trader. If a trader – likely due to a seriously good track record – can negotiate a management fee, this can give him a financial basis to make decisions without the pressure of the high costs of professional trading. Data, Infrastructure cost a lot of money. For a trader that is accepting investors – there are additional costs for legal compliance and possibly auditing. A management fee can offset those costs and allow a trader to focus on good market opportunities.
Although, granted, I would not like to give up a significant part of the profit split for a small management fee.
All in all…
…it can be said that there are some good reasons for a trader to think about trading investor funds. Which is why we also do this. And while it is not decided yet what way this will take (except the fact that we most likely will make some strategies available on Collective2 as a trial), those reasons are good reasons to consider. After talking of the disadvantages of trading investor funds, and the advantages presented here – for us the decision is still not really done. Maybe a third blog post will come to some conclusions.