What is Copy Trading?
Copy trading is a technical term for a practice in which forex traders directly copy the trades of other traders into their trading platform.
Copy trading differs from mirror trading in various aspects; the main difference being, mirror trading generally allows traders to emulate specific trading strategies, rather than specific traders.
Copy trading is a more innovative method of trading, and as stated, the trader or investor does not pass funds to the fund manager as it happens with the common investment methods.
Rather, the trader/investor opens a personal trading account.
From this account, connections to other accounts will be made, including the trader’s account.
It is important to note that all the funds will always be in possession of the investor, and hence, no money will be delivered to third parties.
In other words, the investor in copy trading delegates the control and management of his account unto another trader(s) from whom the trades will be automatically copied.
How Does Copy Trading Work?
How copy trading is conducted varies with the platform that you will choose.
However, the basic principle of copy trading remains unchanged: You inject a part of your portfolio as an investment in a certain trader. You then copy all their trades in a percentage based manner.
In other words, you copy a trader, and anytime that trader makes a trade, your account you will also make a trade in real time.
You allocate some funds to a trader of interest to copy trade, and then using that allocation, in the same proportion as the trader, the trades are copied.
It’s important to note that due to diversification related issues, most of the sites will not allow you to invest more than 20% of your portfolio in a single trader.
This has been regarded as a good policy for obvious reasons: Sometimes traders may seem to do well when they are actually making losses or going through a bad streak. When this happens, anyone who copies or copied them will have to endure losses too. You wouldn’t want to be that trader, would you?
Advantages and Disadvantages of Copy Trading
- Good for New Traders
Every beginner trader is always looking for a working and effective strategy. Copy trading gives you the opportunity to see how others succeed.
If satisfied and convinced, you can use those tactics to make money.
No research whatsoever is required; neither will you need to understand the market before you can start trading.
All you have to do is follow the professionals, and if they do well, then you will do well. It all depends on the traders you copy.
- Good Investment Strategy
The freedom to invest in whatever you like underlies everything here.
You can invest in whatever you like as it doesn’t require a lot of effort or forethought.
You have the choice to either start trading immediately or to watch other traders before deciding to emulate them, or change and move on to another investor if the other one is making losses.
With the freedom of time, you choose whatever time you want to trade. All this happens at your own convenience.
Most of the platforms also assist in managing portfolios with expert advice and suggestions being offered, reducing all the guesswork and helping you make the right choices.
- Confidence Builder
In trading, losing money is a reality as it is not a certain system.
However, the odds of making a successful trade greatly improve with copy trading. With well planned, strategic loss-taking, social trading can be a good way to build some confidence, especially to the new traders, by letting them know that losing money is normal, and not a sign of failure.
There’s quite an explanation as to why serious traders want to learn to trade for themselves, and so is there an explanation as to why, practically, social trading may not live up to its expectations.
Regardless of the success of the trader you are copying, you are bound to make losses at times.
- Costs of Becoming a Professional Forex Trader are Reduced
This is just another of the many benefits of copy trading. Just by using copy trading, you are significantly lowering the costs required to become a professional forex trader. Time and money are two unavoidable aspects of trading. As a trader, you have to create time for learning as well as invest some money.
With copy trading, minimized risks give you the advantage as you can trade with peace of mind. There is no expertise needed at all.
- Risk Management
Copy trading gives traders in the financial markets the ability to automatically copy positions opened and managed by a selected investor, often in the form of a social trading network.
Because of this, risks are effectively managed compared to doing manual trading.
With the array of expert traders available, you can copy as many as you want.
- Money Making Tool (Passive Income)
Because other investment avenues would require more time and effort, copy trading is a good source of passive income.
With little or no knowledge in the field at all, you can start trading almost instantly. As long as you are willing to take risks, it is possible to make a fortune from it.
- Lack of Enough Information
Being misinformed or a total lack of information is a problem affecting most small traders, who fall for the illusion created by other copy trading platforms.
Most portray the image that making money through copy trading is easy and does not require any expertise, skill or knowledge whatsoever.
As a trader, you must equip yourself with the right information and skill to spot the right traders in your portfolio, rather than basing your judgment entirely on past success.
- Lack of Due Diligence
This may appear in the form of:
- Manipulated and inaccurate statistics on the network. This can easily make risky signals appear better than they actually are.
- Bots run without any human supervision. At times, signals may appear to be manually purported but turn out to be bots instead. These bots may result in substantial losses.
- There may be a follower’s risk involved, especially when demo accounts are involved.
- Survivorship bias often leads to an inaccurate analysis of signals, which make the other signals(surviving) look better
- Dishonest Brokers
In trading, there will be insincere brokers who may recommend the wrong traders.
Any good broker who offers copy trading facilities should go an extra mile to examine the stability of a performance before recommending it to you.
Unfortunately, this isn’t always the case as some of them will go on and recommend an account to you without properly vetting them.
Just like in manual trading, it is now almost impossible to predict the outcome of a trade, and this explains the huge percentage of traders who are not actually making any money!
Here are Some Valuable Tips Should you Decide to Try Copy Trading
- Just like in any other investment, focus on diversification. Your investments should be equally spread over to other traders. It is normal for any seasoned trader to have a bad day in the office and when that happens, you wouldn’t want all your eggs to be in one basket, would you?
- Be careful who you choose to copy. In trading, whoever you decide to copy may determine your destiny, as far as trading is concerned.
In as much as there may be a mountain of profiles to choose from, look for the skillful, accomplished and tested traders to work with. For instance:
- Look out for the traders who have already made hundreds of winning trades in the recent past. You will want to work with traders who know what they are doing.
- Online presence is paramount when it comes to trading. Look for traders with a consistent online presence to work with. By being online, you will know how the trade market is fairing hence take the right paths.
- Look for cautious traders. i.e., find the traders who don’t put all their money in a single position/trade. It may also be advantageous to copy traders who take small steps rather than those who go all in.
- Do enough research. The more you know about a trade, the lesser the risks involved.
- Always take time to monitor the trades. This also applies to the ones you decide to copy. Evaluate the traders from time to time to establish whether you are still on the right track. If necessary, make the appropriate changes and save yourself some trouble.
I hope you are now aware of the many dynamics involved with copy trading.