What is copy trading?

Introduction

Copy Trading is a feature that allows investors to trade automatically by following other “Expert” Traders’ trades. The Investor that uses copy trading, doesn’t have any insights on the trading strategy that the Expert trader is using.

Copy Trading can be a powerful tool for new investors and can be used successfully by advanced investors as well as a tool to diversify their trading portfolio.

Key Takeaways

  • Copy Trading is a powerful tool for both Beginner and Novice Traders
  • Copy Trading comes with a lot of Pros and some Cons
  • Experienced Traders use it to diversify their portfolio
  • Copy Trading is generally considered as a good idea to start trading with.

To understand copy trading (Which in some cases is known as Social Trading), you first need to understand what trading is. Traditionally trading means buying and selling things. The main goal in trading is to earn a profit out of selling the items you have purchased. Similarly, copy trading is a form of investment wherein new investors (or followers) can copy other expert investors’ trading patterns, known as the trader (signal provider). 

The main objective in copy trading is to track and find successful traders that have a good profit record and eventually copy their trading patterns. In the financial world, trading means:

A brief history of Copy trading

The onset of copy trading took place around 2005. Before copy trading, traders traded using specific patterns and algorithms, a type of automated trading. It was popularized when two fast-growing financial market sectors, eToro, and ZuluTrade allowed their trader’s accounts to connect and copy their trading patterns. It eventually resulted in a social trading network.

How does copy trading work?

  1. Make a social trading portfolio account in a copy-trading platform. For that, you would need a Broker (for example, Etoro, Zulutrade, FXTM or any other Forex Broker).
  2. Observe, evaluate the performance, and select a trader whose trading patterns you would like to follow. A few considerations on following a trader’s account would be entirely based on your preferences –
    • The rate of profit or returns acquired over the past couple of months or years.
    • The risk level involved.
    • The number of funds they manage.
    • The time holding period of trading assets in stock market trading. There are two types of traders in the stock market trading – the long-term position trader and the short-term intraday trader.
    • Choose between an active trader and a non-active trader.
  1. Decide on the amount of fund you will be investing. The trader has the option to diversify their trading portfolio. Diversifying gives the chance of making money in multiple ways. The trader can allocate their funds on a single trader, among different traders they wish to copy, and various financial instruments.
  2. Here on, it is an automated process done by the copy trading platform. The copy-trading platform will copy or replicate the patterns of your selected trader onto your account.
  3. A follower pays a nominal amount every month to copy trading business models, whose accounts are open as subscription models.
  4. Both parties – the primary trader and the follower who is copying the primary trader, earns a certain percentage on winning trades.

Is copy trading profitable?

There is no doubt that copy trading can yield investors high profits if they choose to copy a successful trader. With the assurance of high returns comes the fact that it involves high risk too. Copy Trading is an investment that works based on probability. The probability that you will make a substantial return is equal to the likelihood that you could lose all your investment capital. One could also face liquidity risk; when the markets are volatile. There are chances of systematic risks too, wherein there could be a sharp decline in the product value.

Example of copy trading cases

Given below are two scenario examples that will help us in understanding copy trading better –

  1. No knowledge about financial markets and trading: Suppose you want to invest in an international or domestic market. You could have zero knowledge about the economy, banking policies, or how financial markets work. Here is when you take the help of copy trading. All you need to know and do is conduct a careful assessment of an expert trader and examine the trader’s performance before following or copying them.
  2. Starting with a little investment fund: Suppose you want to create copy trading with a bit of fund as an experimental hobby. You may want to replicate a trader who has invested an enormous sum of money. Technically his few percentages of the invested capital could be equivalent to your entire invested fund. If that trade loses, the trader’s few loss rates would mean losing all of your investment. Therefore, the copy trading platform proportionally copies the trade patterns of the traders you selected. You give specific instructions on how much to invest in every trader.

Pros of Copy trading

  • Copy Trading’s main advantage is that it allows you to follow, observe, and copy the trading activity of another trade’s expertise. You can start copy trading without any experience. However, with time, you can benefit from the trader’s knowledge accumulated over years and decades of experience.
  • It gives you the chance to diversify your portfolio. There is a vast number of strategies and types of markets to choose and invest in. The benefit of diversifying your portfolio gives you the option to allocate your fund to numerous traders and across varied types of assets.
  • Through the process of copy trading, you can make good profits out of potential investments by merely following your trader’s seasonal trends.
  • Copy-trading with more than one trader creates a balance for the losses associated if one trader is not performing well.
  • It does not take time to start investing and getting returns. However, one factor to keep in mind is your trader’s strategies – it could be a short/medium or long holding period for the investment.

Cons of copy trading

  • As simple as finding a good trader sounds, it takes time and skills to find a profitable trader to copy. There is a risk involved in following a trader, as they could be beginners too, with a higher percentage of risk.
  • Sometimes the traders could have a massive number of followers. It can be a tricky thing to trust those numbers. They could have had a good record by copying other traders themselves. The reason their account shows a good record of accomplishment could be by a chance of luck alone.
  • In some cases, a trader could use the notice boards at the trading platform to intervene and influence a market’s prices. In doing so, they can sometimes do so for their personal benefit.
  • You cannot rule out the risk involved with copy trading as it affects your money that goes into investment. As the nature of trading goes, there are high rewards, but it comes with an increased risk. There could be cases where one may lose the entire capital investment if the assets your trader bought and sold turn out unsuccessful.

Is it a good idea?

Copy trading or Social Trading can be a good idea for investors who cannot invest ample time to follow market trends and market prices. The automated version of copy trading is the most suitable type. There is also a manual version where an investor or trader can execute trading patterns according to their will. Although, manual version copy trading requires a fair knowledge of trading. In copy trading, the investments are generally of the short-term trading type. When going in for copy trading, one needs to understand that past results do not guarantee potential future returns.

Owing to the high risk involved, investors of copy trading can use a smart asset allocation strategy. It means that only a certain amount is affixed to a particular asset or trader. Thus, it protects your account from suffering large losses due to unexpected market dip or poor trading decisions. You can always add more funds after considering the trader’s performance.

Best Forex Brokers offering copy trading

Copy-trading in forex trading is the most sought after, as it is the biggest and offers the most liquid market worldwide. In Forex copy trading, the price movement is frequent, even though it is of a small amount. Some of the best Forex Brokers one can start copy trading with are :

  1. CMC Markets: They provide a range of offerings. They also deal mostly in world currencies.
  2. XTB online trading: They offer tradings at low costs.
  3. Saxo Capital Markets: They are suitable for advanced traders and research.
  4. IG: Best suited for US traders and also the most trusted.
  5. eToro: one of the most comfortable copy trading platform.
  6. TD Ameritrade FX: They are only for US citizens.

Summary

Copy Trading unlike trading signals or Forex indicators can use it to trade on autopilot. You can certainly make money by following Expert traders. Before starting out with copy trading, individuals need to research and be able to understand how to assess the traders that they are considering copying.

Sources

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