What is copy trading?
Copy trading is exactly what the name says. It is a trading strategy that allows an investor (trader) to monitor and follow the same trading strategies of an expert and successful trader (or traders), directly copying the same positions as the expert.
For example: Let us say the trader you are following buys 1 000 shares of a specific company. Consequently, you will automatically buy 1 000 shares of the same company.
A trader who allows other investors (traders) access to data regarding his or her trading strategies and operations, is also referred to as a signal provider or strategy manager.
History of copy trading
As a trading strategy, copy trading originated in 2005 when traders started to copy specific algorithms that were developed through automated trading. Developers allowed others, such as brokers, to copy their trading strategies.
Eventually, traders and brokers acknowledged the potential of systems that allow traders to automatically copy trades of other traders in their personal trading accounts. Hence, a social trading network was formed. Subsequently, copy trading platforms were created to enable traders to connect their personal trading accounts to the platforms.
Copy-trading started to grow in popularity and has since escalated significantly.
Is there a difference between copy trading and mirror trading?
Although closely related, there are slight differences between copy trading and mirror trading.
- Mirror trading, as the name indicates, happens when an investor (trader) mirrors (duplicates) the trading style or trading strategies of other traders.
Companies that make copy trading available, combine the strategies of their expert traders to present reliable and accurate trading signals to their clients.
Mirror trading requires a trader to mirror everything of the trading strategy which he or she follows. The entire process is fully automated, leaving no room for any human input.
- Copy-trading originated from mirror trading and is a refinement of mirror trading.
Unlike mirror trading, which excludes any human input, copy trading allows an investor to choose the specific trader whose trading strategies he or she wants to copy. When the specific trader opens a position, the trading account of the investor will follow suit.
Although fully automated, copy trading allows an investor (trader) to follow and copy different traders at various times. An investor has also the option to follow and copy multiple traders, depending on the type of service the particular trading platform provides.
Types of financial markets suitable for copy trading
All types of financial markets are suitable for copy trading. This includes, inter alia, commodity markets, stock markets, and the forex market.
In addition, trading in cryptocurrencies, indices, and contracts for difference (CFDs) also allows for copy trading.
How to execute copy trading
There are three ways to perform copy trading, namely:
- Manual is almost similar to normal trading where an investor decides who to follow and which strategies or trades to copy. Also referred to as social trading by numerous investors.
- Semi-automated allows an investor (trader) to view and consider all the positions (concerning market commitment or exposure) of the experienced trader. The investor has a choice, either to copy and trade positions individually or to automatically follow and copy the trader’s strategy and positions.
An investor (trader) could copy all the transactions of the experienced trader. Transactions such as take-profit, trade-entry, and stop-loss orders.
- Automated refers to the full package provided by a broker on a trading platform that enables copy trading. This means the investor (trader) chooses the traders and trading strategies that best suit his or her risk profile.
Hence, all positions and subsequent trades are duplicated (copied) automatically.
Basic steps to start and continue copy trading:
- Step 1 – Select a suitable broker
The following aspects are important when deciding on a suitable broker to partner with:
- The broker must be a regulated broker, implying the broker must be registered with the financial regulatory body of the country in which it operates.
In South Africa, the Financial Sector Conduct Authority (FSCA) regulates and oversees brokers.
- Preferably, a broker that offers security, a variety of experienced traders, a wide selection of assets and other trading opportunities, and customer support.
- Step 2 – Open a trading account
Open a trading account on an automated platform that allows copy trading. Usually, brokers offer well-known and secured trading platforms to choose from.
- Step 3 – Select a signal provider/strategy manager
An active trading account enables an investor (trader) to view a list of signal providers along with their performance stats and other information. Such as profitability, number of followers, risk level, the total amount of portfolio, and return on investment.
Select the signal provider(s) that best suit your investment goals.
- Step 4 – Determine your investment amount
Decide how much you are prepared to spend, and how much you will allocate to each trader (signal provider) you have chosen to follow and copy.
You are allowed to increase or reduce the amount allocated to a specific trader, depending on his or her performance.
Regarding fees involved with copy trading:
- Usually, there are no special fees. However, brokerage fees that would apply to normal trades will be applicable to copy trades.
- Signal providers/strategy managers are entitled to a fee whenever they make a profit.
Benefits of copy trading
The many advantages of copy trading are the main reason why it has become so popular. The following list includes a few of them.
Copy-trading:
- Allows easy access to financial markets for newcomers.
- Enables novice investors to familiarise themselves with financial markets, gaining confidence to trade.
- Provides opportunities to new traders to improve their trading skills by following the trading activities of experienced traders.
- Provides opportunities to trade in different financial markets, allowing diversification of portfolios of traders to manage and reduce investment risks.
- Enables more experienced traders to participate in trading, even when they do not have enough time for research.
Disadvantages of copy trading
- All types of trading involve risks, including copy trading. Risks such as market risk and liquidity risk.
- Previous results and achievements of signal providers do not guarantee future returns.
- It can be difficult to find a reliable signal provider.
Featured SA Shares Writer and Forex Analyst.
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