PAMM and copy trading in forex, what are the differences? This article will cover the distinctions between the two, the benefits and drawbacks.
Many investors who appreciate the technical difficulties of self-directed trading in forex have always looked at alternative ways of profiting the markets, leading to the discovery of managed accounts.
Such services are a win-win for all those involved in the transactions. Brokers increase their client base and collect more spreads and commissions; experienced sole traders can leverage their proven performance skills to non-trading investors for commissions; these investors make money passively from replicating the designated trader’s experience.
The two popular types of managed accounts in forex are the PAMM and copy trading, the latter of which has increased more in popularity recently. Some may wonder what exactly the distinctions are between the two since both of them function quite similarly.
Moreover, which option is technically better and why? This article will outline how both operate practically and the benefits and drawbacks that are separating the two.
What is a PAMM account in forex?
PAMM (an acronym for Percentage Allocation Management Module) refers to a pooled account where investors receive compensation according to a percent allocation of the profits generated within the fund.
These accounts involve a designated ‘expert trader’ chosen by a regulated broker acting as the middleman between the trader and investors. Any trades made by the expert traders on their platforms are automatically copied onto the investors’ accounts with risk-adjusted lot sizes.
Investors accept full responsibility for any incurred losses or profits made from the trader’s orders. The investors’ profits are distributed proportionally according to their initial contribution to the pool. This distinction is one of the key differences between the two accounts. Let’s consider an example.
Imagine two investors contributing $5000 each to the pool ($10 000 total) of a trader identified as consistently profitable and worthy of being a PAMM trader.
The profit share is 50% at this point. Let’s assume the trader generates a 10% return after two months, resulting in a $1000 gain. Each investor should receive $500 excluding any pre-determined commissions (typically anywhere from 20 to 50%) owed to the trader for their profits.
If a third person wanted to emulate this trader, the profit allocation would become 33.3%; if a fourth person joined, it would be 25%, and so on.
What is a copy trading account in forex?
In many ways, copy trading is quite similar to its counterpart in that we also have trades copied from a ‘master’ account onto the accounts of investors. More broadly, the former falls into the category of social trading, a communally-driven type of investing where users follow and copy the positions of selected expert traders within a kind of social network.
These trading services are provided by a broker or copy trading-dedicated services like ZuluTrade, with a list of chosen traders selected based on their proven profitability over a defined period. Any positions made by the expert traders are mirrored onto the accounts of their followers through a positional risk-adjusted system.
One of the distinctions with copy trading is flexibility. Investors can subscribe to a wide range of different traders for diversification purposes and usually have very little or no contractual obligations.
In other words, they are free to move between traders based on their preferences since there is no minimum investment time, as is often the case with PAMM. The expert traders typically earn a small fee from every position closed in profit.
Which is technically better between PAMM and copy trading?
We’ve just identified the slightly different versions of managed accounts in forex. So, which is better between the two? There is no correct answer to this question as, like anything else, it depends on numerous factors.
One of the reasons social trading has arguably been more relevant is that commissions are a lot lower and consistent than their counterpart. Investors have the liberty to subscribe and unsubscribe easily.
In PAMM, one typically invests for a specified minimum period which may suit long-term investors with large capital. Copy trading may be regarded as short-term because of its inherent flexible design. Here, it is quite common for more cash-strapped users to participate.
The inherent disadvantage with all such accounts is trusting the discretion of other traders. It’s common for investors to see accounts showing impressive profitability over a short period but with high risks. Thus, the risk of ruin is not entirely removed, and it’s easy for investors to fall into a massive drawdown if their chosen traders also follow suit.
Something else worth mentioning is the inconsistent execution, resulting in wider spreads and slippage. For instance, there could be delays between the time orders on the master accounts are placed and when they are received onto the copiers’ side.
Ultimately, one of the fundamental differences between PAMM and copy trading boils down to profit allocation. With the former, investors receive profits based on a percentage of a large pooled fund. In the latter, there is no such allocation and, instead, they receive profits based directly on the performance of an individual trader.
As already mentioned, copy trading is a lot more flexible with lower and consistent fees compared to PAMM, which has more variable commissions.
These accounts have undoubtedly made the forex markets more accessible to virtually every person irrespective of their background, knowledge, and experience. The roles of investors subscribed to or following a certain designated and experienced trader are reduced to only funding their respective accounts.
This is one of the main benefits, but it doesn’t entirely remove the risk of financial ruin, particularly for less knowledgeable investors. Although self-directed trading takes many years of experience to master, investors need to rely on the discretion of the traders they are following.
Investors should assess the performance of the traders they wish to invest with rather than investing blindly. It also helps to have some basic knowledge of certain metrics such as drawdown, expectancy, risk-to-reward, etc.