Trading can be a minefield for beginners or people who want to get into a specific market but don’t have enough experience yet. Fortunately, there are ways to go around lack of experience and learn while you are making a profit. It’s called copy trading, and it’s a branch of mirror trading that first appeared in 2005. At its core, this strategy is based on social trading and basically allows traders to copy another trader’s trading movement exactly. Copy trading shouldn’t be confused with mirror trading: while mirror trading implies copying an investor’s general strategy (i.e., you like Warren Buffet’s investment strategy, so you start basing your investment decision on his principles), copy trading implies copying another trader’s position exactly.
Copy trading can apply both to the stock market and the Forex market, but it’s more popular in Forex. When used correctly, copy trading offers many benefits: it can help you overcome lack of experience, become more familiar with new markets, avoid rookie mistakes, and avoid emotional trading. However, it is equally important to have realistic expectations. There’s no such thing as zero risks in trading, and copy trading is by no means the universal key to success that traders are so avidly looking for.
With that disclaimer out of the way, let’s have a look at the pros and cons of copy trading and how you can use it to diversify your portfolio.
Benefits of copy trading
Perhaps the biggest benefit of copy trading is that you can gain access to markets without having to research them extensively in advance. For example, if you’re interested in a currency pair but don’t have time to look at the local factors that influence its moves, you can simply copy a trader who has more experience with that. This way, you can also benefit from seasonal trends, and you can achieve true diversification without spending months, even years, understanding technical and fundamental factors. Basically, you can take advantage of bull markets immediately and learn as you’re making a profit.
Getting started with copy trading is simple. It only takes a few seconds to find a list of the best copy trading brokers, and from there, all you need to do is decide who to follow. The whole system is made to be beginner-friendly, so you won’t have to worry about lack of experience.
Another key benefit of copy trading is that it reduces emotional investing considerably. As you probably know by now, not knowing the market is dangerous enough, but if you combine lack of experience with emotional trading, the results can be disastrous. Copy trading reduces some of that risk because you’re copying another trader’s moves, and they should, in theory, know what they’re doing.
Drawbacks to keep in mind
Copy trading has many benefits, but it’s not bulletproofed. Nothing in trading is, for that matter, and we can’t underscore this enough. To make the most out of it, you also need to be aware of some potential drawbacks. For example, the whole idea of copy trading is based on the idea that you’re copying the moves of an experienced trader who know what they are doing. But can you be certain of that? After joining a copy trading network, don’t just pick a trader at random and blindly copy what they’re doing. To avoid unpleasant surprises, first, you might want to look into their track record: for how long have they been trading, for how long do they hold on to assets, how many positions do they have open? Otherwise, you’re throwing your hard-earned money out the window.
Secondly, even if a trade works in someone else’s favor, it might not necessarily work for you because there may be many other factors at play. That trader might have a different strategy, another appetite for risk, or different goals altogether. In the end, the outcome might be favorable for them but harm your bottom line, so it wouldn’t hurt to check if you’re “compatible” before you copy them. And thus, we come back to one of the most important requirements of Forex trading: you need to know yourself very well and not just get in this for fun. If you’re serious about trading, you have to know what you can realistically afford to invest, what risks you’re comfortable taking, and what your end goal is.
And lastly, this is not exactly a drawback, but rather a word of caution: while copy trading is a fantastic way of jumpstarting your trading journey by taking a leaf out of successful traders’ book, it’s not a replacement for trading education, and you shouldn’t rely exclusively on it.
Does copy trading make your life easier? Yes, it does.
Does it make it easier for you to diversify your portfolio on markets that you’d normally need a long time to research? Yes, it does.
But, at the same time, copy trading can also create the illusion of big profits with no work, which can be quite dangerous. That can lead to overconfidence, which can sabotage your success, so keep your expectations in check.
Best practices when copy trading
So, copy trading can be a fantastic tool, but how can you protect yourself from its potential downsides? Here are a few pointers:
- Before copying another trader’s movements, check their track record. Ideally, they should have a trading strategy that’s compatible with yours.
- Copy the movements of different traders to diversify and reduce risk.
- When choosing who to copy, active traders are preferable to inactive ones.
- Manage your expectations. You shouldn’t expect copy trading to be risk-free or loss-free.
- Even if the whole idea of copy trading is to tap into someone else’s expertise, copy trading is not a shortcut, and it’s not a replacement for trading education. Always invest in that whenever possible because it will broaden your horizons and help you be more confident. Who knows, maybe soon other traders will end up copying your movements!
All in all, copy trading can be an excellent way to make a profit when trading Forex, as long as you use it with measure and research the other traders in advance.