A basic explanation of copy trading is that it entails automatically mimicking every operation executed by another trader in order to execute his or her actions on your own personal account.
Copy trading versus social trading
You may have heard of social trading and trading platforms such as eToro that specifically facilitate this. In a sense, copy trading is a subset of social trading. In the latter, broadly speaking, you copy another trader’s moves after having found them to be successful. You can also socially engage with the trader you copied and read their advice posts. It is basically the latter engagement aspect that is missing in copy trading.
Why would someone allow you to copy their strategy? It’s not self-sacrificial – there are commissions involved:
- There is always a spread or commission paid to the broker, whether you make a profit or not.
- These commissions or spreads are usually higher than other standard global spreads or commissions.
- The broker or copy trading company and the trader whose signal you follow gain only if you’ve used real money (as opposed to some kind of demo account) to replicate a trade.
The allocation of funds
You open a trading account and you remain the owner and manager of it. You then connect your account to the signal provider via the copy trading platform. The funds remain yours, and you use the account to copy trades at your discretion.
The key parties
The main copy trading market is the forex trading market. Almost every other market, including CFDs, futures, indices and even cryptocurrency, have now joined.
Then there is the broker who provides a trading account and the platform through which you’ll receive signals from those you’ve decided to mimic.
Finally, there are the signal providers. It is best to choose a platform that provides you with transparent, insightful and accurate data of the transactions of signal providers and the success they’ve had.
Your job is to study this data and evaluate the risk of copying any strategy.
How do you go about copying a transaction?
The platform acts as an intermediary between the signal provider and you. It is responsible for getting the signals to you, tailored to your needs.
For example, you may have $10,000 but want to copy someone with a $100,000 account. What this signal trader – let’s call her Laura – pumps into one move may be equal to your entire capital. Your trading platform is responsible for making sure you copy Laura’s trade proportionally. What you need to do is provide the instructions for how you want to mimic each of your chosen signal providers.
Here’s what happens:
- Laura’s broker sends your platform the data of Laura’s trade as she opens a new trade.
- Laura’s data is then received by your platform.
- Your platform checks who has their settings on copying Laura and the specifications for each one, such as you.
- The platform sends you (or your broker) modified details of Laura’s transaction according to your setting.
- Now you or your broker opens a similar order accordingly.
Most of this process is automated, as are many other trading strategies today, and it only takes a few seconds.
This kind of automated strategy can work well as long as you are always fully aware of the risks. One of the biggest risks is not taking the time to study your platform. What if your settings are wrong and you copy a trade using all of your capital instead of a fraction of it, for example?
Then there’s the risk of becoming so comfortable that you put all your eggs in one basket, which is never a good idea. Always balance your portfolio. This applies as much to risk and instrument as it does to strategy.
Finally, understand the risks of each signal trader’s moves. Take the time to learn CFDs if that’s what your signal provider is trading. A winning streak is no guarantee that the next move is sound.
As long as you don’t see copy trading as something passive that is your only trading strategy or falsely believe it is free of risks, you can enjoy profit-taking on a fairly regular basis.
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