PAMM stands for Percentage Allocation Money Management (PAMM). A PAMM account is a form of managed account service where a single trader with trading experience, creates an account to manage on behalf of himself/herself and other investors who join the program, based on the presentation of profitable trading history in the initial phase of trading the said account.
The aim of the PAMM account is to create a pool of investment funds which can be used to pursue bigger profits for the group as opposed to chasing profits as an individual.
Elements of a PAMM Account
A PAMM account has certain elements which are meant to preserve the integrity of the process and protect the funds of the individual investors within the account.
- A forex broker that offers a PAMM account facility must be chosen for this purpose.
- The account manager must first setup the account and initiate trading, so as to provide a reasonable account history on which performance can be evaluated by future investors.
For the purpose of protecting investors, Managers have to fulfill certain criteria before their PAMM accounts can be listed for selection.
1) Accounts must have been run for a minimum of 3 months, with all data of the account manager confirmed and verified.
2) There is a set minimum for the Manager’s Capital, and this is determined by the PAMM broker.
3) Certain key trade data should be available for Investors to peruse before selection. These include:
- Returns on investment over a 3-month, 6-month or 1-year period.
- Starting account equity
- Drawdown percentage, etc
Creating a PAMM Account
The trader who will actively manage the PAMM account has to create and fund an account using a forex cfd trading broker with a PAMM account facility. This is the initial capital and the trader is known as the Manager. The Manager of the PAMM account must setup the account as well as the parameters on which the account will run:
- Minimum deposit that other investors will apply
- Minimum investment period
- % of profits that the Manager will get from a successful period
- % penalty that will applied if an investor decides to pull capital from the arrangement before the expiration of the minimum investment period.
After some amount of time spent creating an account history (usually three months), the Manager is listed in the rankings and can then solicit for investors to join the PAMM account. Investors can then evaluate the Manager’s trade history and decide if they want to sign up or not.
If trades go as planned and profit is made after the minimum investment period, the Manager is paid the agreed % of profits for services rendered, and the investors can take their profits too. Profits are usually shared in the ratio of the account capital. Both the Manager and Investors at this stage can decide to continue, or end their cooperation. If they decide to continue, the ratios are recalculated for the next season of trading to continue.
If a loss is sustained, the Manager must grow the account back to what it was before being able to pull out profit. Usually, losses are shared in proportion to the ratio of account capital between Manager and Investor.
Let us assume a trader known as Joe registers a PAMM account as a Manager. The parameters of the account are set as follows:
- Account currency: US Dollars
- Minimum deposit for Investors: $1,000
- % share of profits (Manager’s Commission): 30%
- Penalty for early withdrawal: 10%
- Minimum period of investment: 4 weeks
With these parameters well set out, Joe commences trading on the account with a capital of $2000.
At the end of this 1st trading period, he makes $400 profit (20% of the account). The account balance is now $1,200. The Manager decides not to take profit, but to reinvest the profit + initial investment (i.e. $2,400) to attract new investors.
At this time, Joe is able to attract a 2nd investor, who decides to contribute $1,600 to the PAMM fund. This pushes up the capital to $4000. The equity shareholding of the fund is 60% for Joe, and 40% for Investor 1.
At the end of this 2nd trading period, the account grows by $2000. This $2,000 profit is to be shared using the equity shareholding structure:
- Manager’s Profit: 60% of $2,000 = $1200
- Investor 1’s Profit: 40% of $2,000 = $800
By the terms of this offer, the Investor is to pay the Manager 30% of his own profits as the performance fee/service charge for the service. Therefore, the profits of Investor 1 will be split 30:70, with 30% going to the Manager.
- 30% of $800 (Investor 1’s profit) = $240. So Investor 1 retains ($800 – $240) = $560
At the beginning of the 3rd investment period, a third person known as Investor 2 joins the PAMM fund. He contributes $1,000 to the fund. Manager and Investor 1 decide to take their profits and leave their original investment amounts in the fund. The fund is now worth $5,000, and the ratio is now recalculated to stand at 48% for the Manager, 32% for Investor 1 and 20% for Investor 2. The Manager is able to make profit of $2,500, thus growing the fund to $7,500.
- Manager’s Profit is 48% of $2,500 = $1,200
- Investor 1’s Profit is 32% of $2,500 = $800
- Investor 2’s profit is 20% of $2,500 = $500
Investors 1 and 2 have to pay the Manager 30% each as performance fee for the PAMM service. So the Manager earns as follows:
- 30% of Investor 1’s Profit of $800 = $240
- 30% of Investor 2’s Profit of $500 = $150.
- Manager makes $390 as performance fees from both investors. Investors 1 and 2 are left with $560 and $350 respectively.
At the beginning of the 4th investment period, all traders decide to leave their profits so as to try to aim for more profits. The account shareholding is rebalanced and recalculated as follows:
- Manager’s funds = $390 (performance fees from 3rd round) + $1,200 (profit from 3rd round) + $2,400 (original capital) = $3,990
- Investor 1’s funds = $560 (round 3 profit) + $1,600 (original capital) = $2,160
- Investor 1’s funds = $350 + $1,000 (original capital) = $1,350
Please note that profits from 2nd round were already taken out by the Manager and Investor 1, so cannot be added to the calculation. The rebalanced portfolio is now worth $7,500, in the ratio of 53.2% for Manager, 28.8% for Investor 1 and 18% for Investor 2.
The 4th investment round was a losing round for the Manager. The account suffered a loss of $1000. What happens next? The loss is distributed to all participants in the PAMM fund in proportion to their equity shareholding. Therefore,
- Manager loses 53.2% of $1,000 = $532
- Investor 1 loses 28.8% of $1,000 = $288
- Investor 2 loses 18% of $1,000 = $180
For the 5th investment round, the shareholding remains intact, but two things must happen:
- If the Manager makes a profit, the profit must first go to recover the account to the initial value before the loss was sustained.
- Any remaining profits (if there are), will be shared by the Manager and the two Investors. The 2 Investors will be required to still pay the 30% performance fee to the Manager from their own profit share.
The 5th investment round saw a profit of $1,500 made by the Manager. This is how the profit is allocated:
- The account was down by $1,000 after the 4th Therefore, $1,000 from the 5th investment profits would have to go to replace this sum, leaving $500 for the participants to share.
- The Manager gets 53.2% of $500 = $266
- Investor 1 gets 28.8% of $500 = $144
- Investor 3 gets 18% of $500 = $90
- Manager gets 30% from Investors 1 and 2 profits. This equates to $43.20 and $27 respectively.
This is basically how a PAMM account functions.
Advantages of the PAMM Account
A PAMM account presents advantages for the Manager and the Investors.
- A PAMM account presents an opportunity to use trading experience to earn higher income.
- A Manager can attract an unlimited number of investors, which pools in more funds and can greatly compound profits.
- All trades are done from one account without the need to own a multi-account trading software.
- The rules are well known to all participants before commencement of trading.
- Tap into the brains of expert traders and make passive income.
- Manager is only paid a profit for profitable trades.
- Only the investor can withdraw his own funds. The Manager or other investors do not have these privileges.
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