Trading with Investor Money or not - the conclusion

In the first two posts of this series we have collected arguments for both sides – why a trader should not take investor funds, and why a trader should indeed accept investor funds. After looking at both sides, time has come for a conclusion. Like always in such areas, the conclusion is to a large degree subjective.

Still, in this case, there are good arguments towards accepting investor funds, preferably if this happens in a scenario that is mitigating the negative aspects. Those negative aspects run mostly around the legal and litigation side. Accepting investor funds can be a tricky proposition and a trader runs a high risk of being sued if losses occur and his paperwork has been badly prepared.

To avoid this risk, a trader has to look for loopholes. There normally are (in most jurisdictions) exceptions done for traders that are trading other people’s funds on a limited scale and with accredited investors. This means that if a trader is only trading funds for a limited number of high wealth / high income investors (and does not collect the money but trades them from their own accounts) then most of the problems can be avoided. It then runs down mostly to common sense, adhering to the plan and a good lawyer making sure that the representation is ok – all things that do not cost too much or are too hard to follow. Because the trader is not trading his own account with investor funds, there is no need for auditing. And a trader that himself has for example a history as a trader can hardly argue in court that he was not aware of the risk.

Another way to play this is to not accept investors (as in: individuals) but try to work together with a company that has funds available. Consumer investor protection generally does not protect hedge funds or trading companies because those are assumed to be competent. The trader has to find a way to keep his intellectual property protected (especially when trading automated), but this avenue opens up to significant potential funds without the legal issues that come from going to a bulk of investors. It also means that the trader possibly only deals with a hand full of contract partners.

As a starter, a trader may also just want to publish his signals to something like Collective2 and earn money as signal provider. At least in our case this is an approach we plan to take beginning of next year (after our website here got redesigned and our infrastructure upgraded to allow this easily). The other argument against taking investor funds is also quite mood. Yes, trading investor funds means having only a part of the profit, contrary to the whole profit. But 40% (as example) of the much larger pool is a lot more than 100% of no pool – and nothing stops the trader from trading his own account in addition and still get 100% of that money. As such, all income derived from trading investor funds is purely additional income. Once a trader ramps up his own trading he can – if he hits a size limit – decide to scale down investor involvement. This has happened in the past, with traders or even a hedge fund returning investor capital and continuing to trade only on own funds.

The most important argument in favor of accepting investor funds, though, is risk diversification. Once a small trader is growing, he may not want to trade reckless – and investor funds allow his trading funds to grow and at the same time put income into more conservative investments. The way any sensible business man will. Diversification, when done correctly, means that most of the trading profits from his own account will not stay in trading, and that will significantly block earnings growth for an independent trader.

On top, expenses limit `the trader. Trading as a business is not a low cost endeavor – servers, data feeds, all that needs to be paid. A strategy developer needs a lot of infrastructure to run backtests and optimizations. Investor funds allow additional income. Which means that a smaller percentage of trading profits is going towards paying for the fixed expenses of the trader.

How can a trader start with investor funds?

First, he can work as signal provider. A number of websites allow one to publish signals, among them Collective2. I know one trader how started doing that for auditing and now is renting out his systems directly.

Then, he can start talking to accredited investors and trading companies. On the usual social networks one finds references to for example Top Step Traders – which fund futures traders – and a post in a place like LinkedIn may and will get one in touch with potential backers.

This is not necessarily a fast process, but also not exactly a burdensome. There is a big industry and there is a lot of money waiting to make profits. A trader needing investors is not in an unusual situation.

And what will we do?

At Trade-Robots we have decided to try to slowly move in this direction. We are in this situation. We are nicely funded, but we have multiple people working full time on strategy development and that has left to a large amount of strategies that we run on a simulator because we simply do not find the funds to trade them. We will go this step, planning to start publishing signals to Collective2 at some point beginning of the next year (we are behind with this part of our programming, as we will explain in a separate blog post soon). We then plan to do a trial with a Forex broker we have some ties to (which means we have to incorporate Forex into our product mix), which will handle all the legal side issues including the auditing. We do not know where we will take it from there (but it will involve a new website design – we got something nice on our table that we hopefully find the time in December to put in).

Because list most traders or strategy developers – we have funds. Just not enough. And allocating what we would need would totally go against any risk management we have. And at the end, the additional funds of investors will only generate additional income for us.

What is your take on this? Are our arguments sound? Would you go the same direction?