In order to receive funds for your trading strategy, you must take care of a lot of factors. The factors can be the track record of success of your trading strategy in the past, the performance metrics of the strategy, the educational background etc.
You must ensure that, apart from the necessary factors, you are going to the sources you can trust and rely on. This guide helps you learn all about getting funded for your trading strategy. It covers:
- Why would you need funding for your trading strategy?
- Prerequisites for getting funded for a trading strategy
- What to check in the trading strategy for getting the funds?
- Funding avenues
- Associated restriction
Why would you need funding for your trading strategy?
The answer to this question is undoubtedly clear.
So, the same strategy that has been giving you good returns over a period of time with your own funds is falling short of nothing, but funds!
When you have a successful trading strategy, you will surely think of helping yourself with more returns. And why should you not? After all, you’ve worked hard for the same!
Finding funds is not as complicated as it seems once you know who to look for and what to possess for convincing the potential funders.
Prerequisites for getting funded for a trading strategy
Before you approach the potential funders, you must be ready with certain things that will make you look like a serious trader who means business.
Following are the main points to consider when approaching the funders:
- A convincing educational background
- Market knowledge and experience
- A good track record
- Checking the risks in the strategy
Let us find out in detail about these above-mentioned two points.
A convincing educational background
Well, an educational background in finance, mathematics and computer science should be convincing since the funder can build trust in your abilities to create a successful strategy.
The subjects mentioned above can help in the following ways-
- Finance - A good knowledge of finance implies you know the management of finances well and can create a strategy with the right parameters such as stop-loss order, stop limit order etc.
- Mathematics - The mathematical background means you can calculate the probability or the possibility of particular events to take place for a stock, industry and even the market.
- Computer science - The educational background in computer science implies that your coding skills are in place for creating contemporary algorithmic trading strategies.
Market knowledge and experience
The knowledge of the market along with the experience in trading is a good point to bring out while requesting potential funders for funding your trading strategy. It is a point of importance because your experience in the market makes it quite evident that you know the ins and outs of the market behaviour.
The market experience makes you a perfect fit for creating the trading strategy since, apparently, you would know where the maximum risks are.
Moreover, as a person with an experience in the market, it will be assumed that you have gained the experience after a lot of trials and errors and you know what works the best in a particular event!
A good track record
Your strategy has been giving you good returns.
But since when?
And how have you been tracking the performance?
On your broker’s software?
Well, the truth is that if you’re looking to get serious money from anyone, most of the potential funders can be convinced with at least 2 years’ worth of track record with good returns.
Checking the risks in the strategy
You must always keep a check on the risks in your trading strategy by making sure that you’re utlising the risk management practices such as portfolio optimisation, hedging, etc.
Although, there are some traders who are high-risk takers. Still, there are some who like to have their money in relatively stable assets. So you’re good even if you’re able to get consistent single-digit % of profit year on year with relatively low risk.
What to check in the trading strategy for getting the funds?
A trader must check the performance metrics for getting the trading strategy funded and these are:
- Maximum drawdown
- Sharpe ratio
- Sortino ratio
Maximum Drawdown is one of the key measures to assess the risk in a portfolio. In your trading or investment period, your portfolio reduces in value multiple times. These reductions in value are known as drawdowns.
The maximum of these drawdown values gives us an estimate of the maximum loss a portfolio can incur. Technically, it is defined as the maximum loss from peak to trough for a portfolio.
It can be expressed in the formula as :
Maximum Drawdown = Trough value - Peak value/Trough value
You can calculate the Maximum Drawdown of an asset with the help of Python and visualise the same. Below, you can see what the maximum drawdown looks like in the graphical representation.
After finding out the drawdowns for different securities, the trader must go for the security that has a lower or lowest maximum drawdown as compared to others. A lower maximum drawdown indicates slight fluctuations in the value of the investment and, therefore, a lesser degree of financial risk, and vice versa.
In other words, there are much lesser chances of a “significant” loss of your capital.
The upward and downward movement of a security over a period is called volatility. Volatility measures the risk of security. In general, the higher the volatility, the riskier the security. If the price of a security fluctuates slowly over a longer span of time, it is considered less volatile.
Conversely, if the price of a security fluctuates rapidly over a small span of time, it is considered to be more volatile. Volatility is measured by calculating the standard deviation of the annualised returns over a period of time.
Hence, your strategy should include trading with such securities that are not too volatile.
The sharpe ratio measures the risk adjusted returns in a trading strategy. Higher the sharpe ratio, the more the returns a trader is getting per unit of risk. The lower the sharpe ratio the more the risk a trader is taking to earn additional returns.
Sharpe ratio is given by the following equation:
Sharpe ratio = (Rp - Rf) / σ
For example, you have a portfolio out of which you expect an annualised return of 12%. Let us also assume that the risk-free rate is 7% and your portfolio carries an 8% standard deviation.
The sharpe ratio for your portfolio would be calculated as:
Sharpe Ratio = (12% - 7%)/ 8% = 0.625
However, for bringing the sharpe ratio to use, you need to compare two portfolios’ sharpe ratios and find out which one gives you more risk-adjusted returns. In other words, a higher sharpe ratio will have a potential for more returns per unit of risk.
The Sortino ratio is similar to the sharpe ratio. The only difference is that the sharpe ratio involves both the upward and the downward movement of volatility while sortino ratio represents only the downward movement of volatility.
Just like sharpe ratio, the higher the sortino ratio, the better the return for unit risk.
Since most of the traders are only concerned about the downward movement of volatility, the sortino ratio represents a more realistic picture of the risk going down.
The choice of using sortino or sharpe ratio for evaluating a strategy is solely based on the individual, whether he/she wants to analyse the total volatility or the downside movement of volatility.
Sortino ratio is calculated as follows:
Sortino ratio = (Rp - Rf) / σd
Rp = Expected return
Rf = Risk free rate
σd = Standard deviation of the negative asset return
For example, a company XYZ has an annualised return of 11% and a downside deviation of 9%. The risk-free rate is 3%. The sortino ratio for XYZ would be calculated as follows:
Sortino ratio = (11% - 3%) / 9% = 0.88.
You can find the sortino ratio of two portfolios and compare them to figure out which portfolio has a higher sortino ratio since a higher sortino ratio implies a higher return for risk.
There are some funding sources we will discuss now that a trader, with a successful trading strategy, can approach. Take a look at some of the potential funders I have listed below, and they are:
- Family and friends
- Proprietary capital
- Agreement with broker
- General public
Family and friends
The most convenient and quick source for getting your trading strategy funded is reaching out to your family and friends. Well of course this does not mean that you should take advantage of their emotional bond and compel them to fund your strategy.
This only means that you can convince someone from your family and friends to fund your trading strategy. Your friends even can be the ones on social media who will trust you.
You can base your convincing talk on the facts by showing them how your trading strategy holds minimum risk and more probability of maximising the returns. You must explain all the risks and be generous by offering them a good share of the returns.
You can also raise the funds by tying up with a proprietary trading firm by convincing them of your successful trading strategy (with good performance metrics).
Your partnership with the proprietary trading firm should be on the terms where you and the firm mutually agree upon some percentage of returns for you in exchange for your strategy.
Agreement with a broker
To raise the capital for your successful trading strategy, you can get into an agreement with a broker with whom you can trade the securities on a partnership basis. Just like tying up with a proprietary trading firm for raising the capital, you can partner with a broker on some terms with regard to the returns.
If you are a person who can market the trading strategy to the general public via social media communities, then you can raise capital from them by gaining their trust.
You need to keep a few things in check for making sure that you are perceived as an authentic individual as well as a trader. I have summed these necessary points below:
- Your family or/and friends can vouch for your authenticity on your social community (as an individual as well as a trader) to help the public (who are usually strangers) be sure of your identity.
- Apart from the knowns vouching for you, it is important that you provide the public with details of yours such as a genuine country ID.
- Further, you might also need some licences to go forward with raising funds. You may be required to get a licence like Alternative Investment Fund (AIF) or Hedge Fund, Fund Management Company (FMC) or Portfolio Management Services (PMS), etc. based on the asset class, jurisdiction and the type of investors from whom you are raising the capital.
Going forward, we will now find out what can be the associated risk of raising the funds for your trading strategy. The traders who receive funds for their strategy need to simultaneously abide by the rules and regulations of the sponsor.
These rules include a limit on daily losses, fewer maximum drawdowns and optimised strategy etc. Hence, when you raise funds for investing in your trading strategy, you need to respect the funder's risk management practices as well.
Getting funds for your trading strategy is a bit complicated but not impossible. When you wish to have more funds for a successful trading strategy, you need to keep a few points into consideration. Also, there are various funding platforms that are worth a try!
If you also wish to know more about creating a successful trading strategy and get funded for the same, you must enrol in this full-fledged 6-month algo trading course. It can help you to be able to learn various ways of creating a good trading strategy for raising funds.
Note: The original post has been revamped on 29th July 2022 for accuracy, and recentness.
Disclaimer: All investments and trading in the stock market involve risk. Any decision to place trades in the financial markets, including trading in stock or options or other financial instruments is a personal decision that should only be made after thorough research, including a personal risk and financial assessment and the engagement of professional assistance to the extent you believe necessary. The trading strategies or related information mentioned in this article is for informational purposes only.