How to Evaluate a FOREX Manager’s Performance
Reward and RiskUltimately, a manager's performance is about six factors:
- Reward -- How much can he or she make for you?
- Risk -- How much risk is taken to achieve those results?
- Sustainability -- How long has the manager been able to support performance?
- Volatility -- How wide swinging is the performance or equity cycle?
- Frequency -- How often does the program trade?
- Cost -- What are the fees for services rendered?
It is important to consider how frequently a manager executes trades for her program.
The disadvantage of short-term programs is cost. The pips add up when many trades are made quickly. The disadvantage of long-term programs is exposure to the various news releases, which can shake a currency pair, reversing and even fully negating a long-term trend in hours if not minutes.
The Equity Cycle and DrawdownsNo trader's performance goes straight up; even the best managers have drawdowns. These are periods -- weeks, months, quarters, even years -- when performance goes down instead of up. The equity cycle for a FOREX manager -- if it is long enough -- can also tell you much about where he sits on the risk-to-reward continuum. A relatively gentle cycle with soft drawdowns indicates a conservative approach, all other things being equal. A more violent equity cycle with fast and dramatic drawdowns may indicate an aggressive program. There is no escaping it; risk and reward are forever linked. The more of the latter you want, the more of the former you must be willing to accept. This is certainly a decision you must make before opening a managed account.
Tip: If you believe in the long-term viability of a FOREX manager's program, examine the equity cycle and invest a small amount to begin with and more after an average-size drawdown.
Equity ExposureThis is about risk. The more of your account allocated to open trades at a given time, the higher your exposure. This value has a wide range based on the type of trading method, but anything over 75 percent exposure is very high.
Assets under ManagementTo a large degree, the long-term success of a manager is measured by how long he has been in business -- denoted by the amount under management. Success is always noted and rewarded. Functionally, there is no difference whether a manager makes a trade for 20,000,000 or 200,000 EUR/USD for his clients.
Track RecordYou will want to analyze a manager's track record for all of these factors before making a decision and committing to an investment. How complete a track record a manager publishes will tell much all by itself. A simple table showing net results on a monthly basis does not allow for a complete analysis. The more information, the better. You certainly want to see the amount under management on a periodic basis as well as the Sharpe Ratio. Few managers release their actual trades, unfortunately. But as you find some who do, refer to some price charts to see how she does in different basic market environments. Then observe if the manager is hitting them hard in the positive environments and lying low in the negative environments.
A track record may either be a real-time or back-test, or both. Newer programs that have a short real-time experience often show the back-test results to give a better view of performance. A back-test may be as adequate a measure of performance as a real-time one -- but only if the former is conducted properly, and most are not. If the manager's information does not state whether performance is real-time or a back-test, ask.
If a track record is a combination of real-time and back-test, ascertain that both are using the exact same program. A long-term real-time performance is considered most reliable. A performance of only a back-test is considered to be the riskiest.
Tip: Be sure the track record you review is for the exact program for which you are considering an investment. A long-term track record may be a tapestry of a half-dozen different systems for which the manager changed gears and retro-fitted or curve-fit the program every time it began losing money. As in trading for yourself, tweaking a system is good -- evolutionary change -- but frequent revolutionary changes are not good.
Achilles' HeelAll traders and all programs have weaknesses. Usually, one predominates. A good manager who has been in the FOREX trading business for a long time will have learned how to mitigate and minimize those in his program.
Performance analysis asks this core question: "How much can I make for how much risk?" Basically, this is the risk-and-reward ratio of a money manager, and that is the information you seek from performance and track record analysis.
By Michael Duane Archer