Copy trading has transformed the way people participate in financial markets. Now, it’s no longer necessary to spend hours trying to grasp complex trading strategies or monitor market trends – by leveraging copy trading, you can copy the trades of seasoned traders automatically, making it easier to profit from the markets, even if you are a beginner.
Copy trading is a concept that has been around for a while, but it has now become more accessible due to the development of social trading platforms. While this strategy offers numerous advantages, it also has its drawbacks, and it’s essential to understand both. In this blog, we will break down the concept of copy trading in detail, outlining what to expect when using it. Read on!
How copy trading works
If you want to get started with copy trading, you need to choose an experienced trader whom you find trustworthy in terms of their performance and strategies and link your trading account to theirs. Once you do that, each of their trades will be replicated in your account in real-time, which gives you the opportunity to benefit from their expertise without having to manage your trades directly. Here’s how the process works generally:
- Selecting a trader. The first step when getting started with copy trading is, obviously, selecting a trader. Most platforms offering copy trading also include detailed profiles of lead traders that may be suitable for you, focusing on risk metrics, performance history, trading frequency, and the assets they typically trade. When choosing a trader, make sure to assess their risk levels, strategy, and track record, as this will help ensure they align with your risk tolerance and investment goals.
- Establishing your investment amount. After choosing a trader, it is time to figure out how much money you want to allocate towards this endeavor. The platform will enable you to adjust your account’s percentage that follows the lead trader – in other words, if you want, it is possible to mitigate risk across various traders.
- Automatic trades’ replication. Whenever the trader you’ve selected makes a move – whether opening or closing a position- this move is replicated in your account. If the trader allocates 10% of their account to one of their trades, this amount will also be deducted from your account.
- Adjusting the allocation or stopping the copy. If you want to adjust the allocation or stop copying altogether, you can do so at any time. This flexibility enables you to make the necessary adjustments by considering market conditions, performance, or changes in your investment goals.
- Built-in risk management features. Many copy trading platforms give you access to risk management tools, such as Stop Loss orders, meaning you can easily establish predefined limits that will help you mitigate losses in case the trader’s strategy performs poorly.
The benefits of copy trading
Copy trading is very popular among experienced and inexperienced traders alike due to its benefits:
- Time savings. Trading can be time-consuming, especially when done manually, and requires constant monitoring of the markets. However, copy trading helps automate the entire process, thus saving time. This can be especially beneficial for busy professionals or individuals who have other commitments, as they can participate in the markets without constant involvement.
- Ease of use. Accessibility is one of the greatest appeals of copy trading. If you are new to trading, you may find it daunting to handle all the aspects of it, including risk management, market analysis, and strategy development. Thankfully, copy trading eliminates these challenges, as it enables you to benefit from the expertise of experienced traders.
- Portfolio diversification. Copy trading also enables portfolio diversification, which is another excellent benefit. In traditional trading, you can only focus on one strategy and market due to knowledge and time constraints, but copy trading enables you to allocate your capital across different traders using various strategies. For instance, beyond crypto, you could also follow a trader focused on stocks and another one specialized in Forex trading, helping you spread exposure across various strategies and assets, thus mitigating risk.
- Learning opportunities. Even if copy trading is automated, it provides an excellent educational opportunity because you can observe experienced traders’ choices and learn from them. Moreover, many platforms provide detailed trade history and performance data, meaning you can analyze the types of trades executed as well as the rationale behind them, which can be truly invaluable if you’re looking to improve your trading skills.
The downsides of copy trading
While it offers plenty of benefits, copy trading isn’t risk-free, and it’s essential to be aware of its downsides before diving in:
- Over-reliance on another trader. Copy trading means trusting someone else to influence the outcome of your trades, but although you benefit from their expertise, there’s the risk of relying too much on their decisions, and this can backfire. No matter the skills and experience of a trader, they can still make mistakes and face losses. This is why it is essential to diversify the traders you choose to copy, because it will help decrease risk by avoiding being overexposed to the performance of just one individual.
- Copying risky strategies. A trader’s performance history can be appealing when deciding who to follow, but a high level of profit may also involve a high level of risk. Some traders rely on risky strategies like high-frequency trading or scalping, leading to significant fluctuations in their account balance and, therefore, increasing the risk of major losses. When choosing a trader to copy, make sure to assess the risk metrics on the platform, to ensure you are comfortable with taking that amount of risk.
- Market volatility. Copy trading comes with volatility. Markets can experience fluctuations due to geopolitical events, economic data, and unexpected news, resulting in sharp price swings. This means that even if you copy a trader with a robust track record, their strategy may not perform well during highly volatile conditions. This can be mitigated by monitoring the market and the trader you’ve chosen.
The bottom line
Copy trading offers exciting opportunities for traders, regardless of their level of experience, enabling them to participate in the markets with less effort. However, it’s critical to approach it responsibly by choosing your traders carefully, and considering risk tolerance, and the trading strategy of your chosen trader.