The Trouble With Forex Track Records

Forex Track RecordThe trouble with Forex track records is they are challenging to verify.  One easy way to confirm a track record is by giving it a “common sense” audit.  Ask yourself these two simple questions:

1. Does the track record deviate from the average track record of other well-established funds?

2. Is the record too consistent over time relative to other programs whose records are verified and audited?

If the manager of a Forex fund or managed account program states  “my program is up ++20% per month for the last 12 months!”; you can be almost 100% sure that the manager is lying, or he has only a few hundred dollars under management, or it is a proprietary trading operation that does not need the public’s investment dollar.

Forex Funds And The Sharp Ratio

The Sharpe ratio is a measure of risk-adjusted performance that indicates the level of excess return per unit of risk. In the calculation of Sharpe ratio, excess return is the return over and above the short-term, risk-free rate of return and this figure is divided by the risk, which is represented by the annualized volatility or standard deviation.

In summary, the Sharpe Ratio is equal to the compound annual rate of return minus rate of return on a risk–free investment divided by the annualized monthly standard deviation. The higher the Sharpe ratio, the higher the risk-adjusted return.  If 10-year treasury bonds are yielding 2%, and two Forex managed account programs have the same performance at the end of each month, the Forex managed account program with the lowest intra-month P&L volatility will have the higher sharp ratio.

At A Glance: Forex Managed Account Track Records

Not too long ago, a trader asked me to review his track record, but I only had 5-minutes to do the review.  Is it possible to examine a track record in five minutes?   The answer is: yes. It should just take a few minutes to analyze a well-documented Forex track record*.

Unfortunately, most track records are poorly organized and difficult to glean any information from regardless of how long the reviewer has to peruse the trade statistics.  Well-organized track records will tell the reviewer the following (not listed in the order of importance):

  1. The Forex trader’s name,  location and the name of the program.
  2. Regulatory jurisdiction.
  3. Brokers name and location.
  4. Amount of assets that are under management.
  5. Peak to trough draw-down.
  6. Length of the trading program
  7. Month by month returns and  AUM

The Challenges of Investing in Emerging Forex Traders

Investing in emerging Forex traders (these traders are sometimes called managers) can be extremely rewarding, or it can be extremely disappointing.  Similar to athletics, catching a rising star before anybody else notices a person’s talents can be financially rewarding for both the discoverer and the discovered.  Generally, as assets under management grow, returns shrink. And here’s the paradox: the longer you wait for a manager’s track record to become statistically significant, the more likely it is that that manager is going to acquire more assets under management and the managers track record will suffer due to the law of diminishing returns.  We all know it is easier to manage a $100 thousand vs.  $50 million.

Investors who take that first chance on emerging trader can make a fortune.  The initial investors in Warren Buffet and Paul Tudor Jones funds are now multimillionaires, or possibly billionaires.  How an investor picks an emerging manager is as much of an art as it is the science.

The art and science of picking emerging managers will be a topic of Forex Funds blog post shortly.

Drawdowns Explained

An investment is said to be in a drawdown when its price falls below its last peak. The drawdown percentage drop in the price of an investment from its last peak price. The period between the peak level and the trough is called the length of the drawdown period between the trough, and the recapturing of the peak is called the recovery. The worst or maximum drawdown represents the highest peak to trough decline over the life of an investment. The drawdown report presents data on the percentage drawdowns during the trading program’s performance history ranked in order of magnitude of loss.

  • Depth: Percentage loss from peak to valley
  • Length: Duration of drawdown in months from peak to valley
  • Recovery: Number of months from valley to new high
  • Start Date: Month in which peak occurs.

Forex Funds And The Standard Deviation Measurement

One of the most common measurements used by professional investors when they are comparing Forex funds track records is the standard deviation.  Standard deviation, in this case, is the level of volatility of returns measured in percentage terms over a period of many months or even years. The standard deviation of returns is a measurement that compares the variability of returns between funds when combined with data from annual returns.  Everything else being equal, an investor will deploy his capital in the investment with the lowest volatility.