If you’d like to share in the profits of skilled traders, but don’t have the time to master their complex strategies, technical and fundamental analytics, or complete command of their own emotions, why not copy them instead?
There’s no such thing as plagiarism in the markets – many traders describe their ongoing trades as they do them, and there are many ways to trade in tandem with experienced market participants. One thing they don’t do is tell you what they’re planning in advance – we will see why in this article.
What is copy trading?
Like social trading, copy trading is a way of using your relationships with other traders to improve your own trading. Unlike social trading, copy trading involves a formal, paid relationship with a particular trader, who shares information about his recent trades which you immediately execute on your own account.
Advocates claim that copy trading is the ideal way for new participants, who are unsure about how the FX market works, to join in the profits of experienced traders. Various automated programs exist to allow you to run a copy trading system without any input beyond selecting the trader to copy and making your initial deposit.
How does copy trading work?
First, you identify the trader you want to copy. Many high-performers will offer a copy service, and lists are available on most platforms, showing monthly performance, maximum drawdowns, and length of trading history. Try and find traders who are aligned with your investment philosophy – are you aggressive or risk-averse? Are you comfortable with volatility? Answers to all of these questions should be found in their profiles and trade history.
Once you’ve selected a trader, place your deposit, which is then allocated in the same proportions as the trader’s account. So, if the copied account allocates 10% of his portfolio to EURUSD, your account automatically does the same. A typical minimum account balance would be $1,000.
How to select an account to copy
The most important decision is which copy trader (or copy traders) you plan to follow. Be wary of copy traders showing massive monthly gains with short histories – consistent profits are much harder to make than short-term gains. Keep a close eye on their past drawdowns as well; would you be comfortable losing this much of your portfolio?
Good copy traders will provide detailed descriptions of their strategies, possibly with worked examples. Pay close attention to this information and try to find a trader who aligns with your investment objectives and risk appetite. Copy trading can be helpful when there are gaps in your investment knowledge, but it is never a substitute for financial education. Always be wary of things you don’t yet understand, and don’t just rely on return history to reach a decision.
You will often hear mirror trading, copy trading, and social trading discussed together. The differences with social trading are described above and here. Social trading is a great way to improve your financial knowledge, but it is a slow learning process and not always the best option for absolute beginners.
Mirror trading and copy trading are more similar, with the main difference being the nature of the account that is copied. In a mirror trading account, instead of copying a specific trader, you buy into an algorithmic strategy. This is presented in a similar way to a copy trader profile, with past history and monthly returns, but the account operates slightly differently.
While a copy trading strategy will mimic the trades of a human FX trader, a mirror trading account executes trades according to pre-set rules. This can be advantageous if the trader concerned makes an emotional error, but it removes a layer of oversight and could equally lead to losses. It is important to choose the right method that works for you.
You should also remember that in practice, the difference between mirror and copy trading isn’t always clear, since many copy traders use 100% algorithmic strategies. Either way, by careful vetting and close monitoring of account performance, you can protect your investment. Never be afraid to close an account if you are not happy with its performance.
Forex copy trading
Copy traders work in all markets but are most commonly associated with forex trading. There are lots of reasons for this, not least relatively low transaction fees compared to bond and equity markets.
- Most copy traders use technical or quantitative strategies, which are easy to execute in the FX market due to high volumes and constant trading without breaks or market closures.
- FX, compared to commodities or equities, is a simple product that doesn’t require physical delivery, or have additional concerns like dividends and voting rights.
- Because of the vast liquidity of the forex market, it is usually possible to execute large trades without moving the market. Nonetheless, copy traders will only reveal their trades after they happen, to avoid other traders moving the market against them.
Who is copy trading for?
Copy trading is popular with a wide range of traders. Beginners and the time-strapped love it because it allows them to trade forex without committing long periods to study and practice, but it is also popular with more experienced traders who find themselves making frequent emotional errors.
It’s important not to view copy trading as a ‘money machine’ you can simply turn on and ignore. Yes, copy trading allows you to benefit from the actions of traders with more experience than you, but it still requires an understanding of the markets and a desire to educate yourself. Combine any copy trading strategies with self-education so you can make informed decisions about your money. That way, when you copy pro traders, you will learn from them too.
Things to watch out for
All trading strategies come with risks, but there are a few specific points to watch out for while copy trading.
- Be aware of costs – multiple transaction fees can eat into the profits of following a trader.
- Think about how much involvement you want.
- Vet the copied account carefully and constantly monitor performance to ensure it is meeting your objectives.
Understanding returns: Position sizing
There are obvious things to look at when choosing copy trader accounts, such as annual and monthly profitability. These can give a good indication of a trader’s track record – but remember more risky strategies tend to include both higher profits and greater drawdowns.
Whichever account you choose to follow, position sizing is a very important concept for copy traders. If the account you are following has a portfolio size of $1 million, they may assign 1% of their portfolio to a particular currency pair. At $10,000, this is a sizeable trade which won’t be too impacted by fixed fees.
Your portfolio, however, might only have a balance of $1,000. In that case, copying the trader will involve assigning 1% of your portfolio to the same pair: $10. A small fixed fee would completely erase any expected gains on such a small transaction. Always check the kind of trades the copy trader is making and match your portfolio size accordingly.
Copy trading in Australia
Unfortunately, the Australian copy trading market took a major blow in 2020 when 1,200 Australians, many of them young traders, saw their investments wiped out in 48 hours by a rogue trader.
Determined to prevent a repeat of the same disaster, the national regulator (ASIC) launched an investigation and introduced tough new rules on the sector. Fortunately, a repeat is much less likely today, but the episode remains a cautionary lesson in proper vetting.
Despite this incident, with continuing retail interest in copy trading Australia is at the forefront of its global adoption. Rakuten thoroughly vets all copy traders before including them on its platforms, so you can have peace of mind when copy trading.
How Rakuten can help
Copy trading can be a powerful tool for making returns while you learn more about trading and the market. Rakuten offers an intuitive, well-vetted copy trading capability powered by myfxbook.
With Rakuten, the process for following a trader is simple; just select from one of our many vetted traders, check their record and history, then open an account to begin copy trading today.
If you want to experiment with copy trading before committing any of your capital, sign up for a free demo account today and begin placing trades risk-free.