Copy Trading: Important Risks and Advantages to Take into Consideration

Copy trading is one of the popular trading strategies that allows traders to copy in a step-by-step manner the trading moves of other traders, commonly considered to be experienced and successful. Copy trading is a good way to start a trading journey without conducting long time-consuming research of markets and instruments. However, mechanical copying of steps made by other traders has its particular risks and benefits. These risks and advantages, as well as useful tips and rules of copy trading, are gathered for your convenience in this article.

The Key Question: Is Copy Trading Really That Profitable?

If we start with the numbers, they are impressive. The copy trading strategy brought to the traders using it the revenues of about $50 billion in 2020. Judging by the steady growth of interest in this kind of trading, this number can increase to $80 billion by 2025. So, yes, copy trading is profitable, but with a caveat.

As with any other trading strategy, copy trading can bring profits if done right. Since it does not require you to conduct prolonged research on the price history and behavior of the asset you plan to invest into, you can start trading right away. You can copy traders who deal in a huge array of assets, from forex and gold to stocks.

The Essential Downsides of Copy Trading

The first big risk is that you will entrust your money to a trader who is not experienced or professional enough to deliver the results he/she promises. So picking a trustworthy trader is your task number one before you make any real trade.

Other risks of copy trading are connected to the nature of instruments and markets you are going to work with. Fluctuations of prices, FOMOs, unexpected economic events that impact the valuation of instruments significantly, and many other factors can put your investments at risk.

The first big risk is that you will entrust your money to a trader who is not experienced or professional enough to deliver the results he/she promises.

The Popularity of Copy Trading Explained

For copy trading, you don’t have to study hard for months (or years) before starting actual trading. You can enter the market when you have sufficient means to do it. The rest is performed by a trader, and you only have to copy their actions.

Copy trading can be done automatically, without your direct involvement. So, if you cannot allocate a lot of time to trading, copy trading is a solution for you. Pick the online platform, choose a trader, and set the automatic copying of all trades, from entry to profit-taking. Then you will not have to copy every trade manually, which may be time-consuming. You can also set the amount of your capital to invest (the whole sum or a part of it).

Another way to copy trade is to receive notifications about trading steps to take, for example, the exact descriptions of positions to open and stop-losses to set. Then you will perform the actions in your account. It takes more time but gives you control over what trades are made in your name. If some trading action looks too risky to you, you can skip it.

Copy Trading: a Strategy Suitable for Beginners

Unlike solo trading, where you make all the decisions, in copy trading, you tap into the experience of professional traders who follow the news regularly and are skilled in technical analysis. So, their expertise is, to a certain degree, a safety-lock against the most common mistakes newbie traders make.

This is why copy trading is a good kick-start for a beginner’s trading career. You can learn along the way, analyzing and observing the steps taken by other traders. Definitely, you won’t get access to the plan behind the moves and the overall vision that guides the trader you copy.

Yet if you compare the actual trades to the situation in the market, you will gain insights into how others reason, how they go with the market or act against it, and what the outcomes of their approach are. It is one of the best experiences you can gain from copy trading. So while letting other traders guide your first steps, educate yourself, read overviews and prognoses and compare them to your copied trading moves. In such a way, you learn and you trade for profit at the same time.

Commonly Acknowledged Benefits of Copy Trading

If we sum up all benefits of copy trading, we will come up with the following list:

  • Like any valid workable trading strategy, copy trading is profitable;
  • You can start performing real for-profit trades right from the start, without doing lots of preliminary research, which is time-consuming;
  • As a beginner, you can learn a lot from the signals and details shared by other traders. If you do your research and gain insights into the principles of trading and existing strategies and approaches, you will understand the reasoning behind the set of signals shared with you and will be able to apply it when trading on your own;
  • Copy trading is a kind of safety lock against the typical newbies’ mistakes, and so, against totally preventable money losses;
  • Copy trading can be fully automated, so you do not have to be involved every time the position needs to be opened or closed.

The Key Risks of Copy Trading to Consider and Avoid

The essential risks are also there, and you need to be aware of them.

a) Risk of an error/miscalculation made by a trader you copy

The main risk connected to copy trading is that you may automatically copy mistakes made by a trader you follow. Copy trading only gives you access to specific steps a trader makes, without explanation of an overall strategy and deep market analysis applied in decision-making. So, if a trader miscalculates or succumbs to FOMO, you will do it, too, even without knowing it. If a trader loses their money, you will lose, too.

The way to manage risk to some extent is to inquire what was the biggest loss carried by a trader. The dropdown of around 20% or below is tolerable since the market is volatile. But if the loss was bigger, reaching 30% or 40%, we recommend that you look for another trader.

b) Asset volatility risk

It’s another important risk to consider. There exists a big toolkit of instruments that help traders predict where the price will most likely go, and often these predictions are true. Yet volatility of the asset value is not always based on objective reasons, and some unexpected events, so-called black swans, can hit the markets or specific assets very hard. The price will drop radically and unpredictably, and you will lose your money. It won’t be the trader’s fault, it’s the inherent asset volatility and hidden factors that can play a fatal role in the price drop.

The only sure way to avoid significant losses due to this factor is to keep your portfolio diversified in all senses. Follow a few traders who trade at different time intervals and invest in different instruments. So if one asset fails, others will keep your portfolio afloat.

c) Liquidity risk

This risk means that it may not be possible at some point in time to exit your position immediately when you need it. It may happen in emerging markets where the local currency pairs are not so lucrative as to sell fast and at the desired price. So you may get stuck with unwanted illiquid assets while their price drops. In comparison, a position in the popular currency pair EUR/USD can be easily liquidated at any time because demand for both currencies is steadily high.

The way to avoid forex copy trade risks or minimize them is to check the slippage a trader incorporates into the predicted returns. Attention should also be paid to the transaction commissions and spreads and how they relate to the trader’s returns.

d) Systematic risk

This risk is associated with global factors and related to the market as a whole. Emerging markets are called so because countries of these markets are going through the process of establishing governmental and financial systems, and these systems are still fragile and prone to collapsing. So if a coup happens, a national emergency is declared or a country defaults on its internal and external financial obligations, your funds in the form of assets will be locked inside the country with vague prospects of returning to you.

This risk is not as prevalent as the ones mentioned above, but still, its possibility should be considered as well. Check the current political situation and prognoses about financial matters of the country the currency of which you are going to buy.

The Rules for Performing Copy Trading Successfully

To follow this trading path successfully, you have to observe a set of rules, so to say.

  • Conduct at least a bit of research. Define what you want to achieve and what assets you want to engage in. Then pick a trader in the corresponding field.
  • Pick a good broker to follow. A truly successful trader will definitely have:
    • many followers (and proof of following);
    • a record of performance with positive outcomes (trading results presented by months or quarters);
    • and the history of steady returns on investments made (on an above-average level, preferably). If a trader you plan to copy cannot present any proof of market success, you should consider finding another trader.
  • Clarify the fees system of a given trader: you can pay a subscription fee for getting the insights or give away a portion of revenues received through copy trading.
  • Diversify. That’s probably the key risk management advice. The general recommendation not to put all eggs into one basket holds true for copy trading: diversify the trading accounts you copy and assets you trade. Then, if some asset loses its value radically or a trader miscalculates, other positions in your portfolio will compensate for that failure.
  • Don’t invest every single cent into trading. Invest only as much as you can afford to lose without going broke.

The general recommendation not to put all eggs into one basket holds true for copy trading: diversify the trading accounts you copy and assets you trade.

Afterword

As you see, copy trading is a valid and profitable strategy, if performed correctly. So choose a trader to copy carefully, do not invest all you have, and diversify. In addition, you can practice copy trading virtually, and then enter the market in full knowledge of what to do (and what not to do). We highly recommend getting some practice first, and Justforex will be a trusted adviser in this undertaking. Then, your copy trading will bring you only positive experiences and significant profits.

by Justforex, 2021.11.23

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