What is Copy Trading, How it Works and Where to Start
So you want to find out what is Copy Trading, how it works, and what are the best options to begin with?
You could not find a better post.
In this post you will find:
- Explanation of what Copy Trading is
- Who are the main players
- How does signals replication work
- Who is the Signal Provider
- Who is the Follower/Investor
- What are the risks
- What are the best options and resources to start
What is and how Copy Trading works
Copy Trading is an innovative investment methodology.
Today you probably hear more about Social Trading, and the trend is to call everything with that name, creating also a bit of confusion (read here the differences between mirror-copy-social trading).
For precision sake, here we will discuss specifically Copy Trading.
With Copy Trading the investor has the option to automatically “copy” every operation executed by another trader, in order to replicate his performance on his own personal account.
With a Copy Trading service the investor does not give his funds in the hands of the fund manager, i.e. the other trader (as happens with the common investment methods).
In this case, the investor simply opens a personal trading account, which he keeps the property of, and then, via the Copy Trading platform, he connects his account to the designated trader one’s.
In practice, funds are always in possession of the investor, there is no delivery of money to a third party.
Simply, with Copy Trading the investor delegates the management of his account to another trader (or more then one) from whom he automatically copy the trades.
The main players
What are the essential components at the backbone of Copy Trading?
There are several versions and nuances in the multitude of services offered, but essentially these are the basic components of any Copy Trading service.
Being a financial instrument, is obvious that the entire structure is developed on a financial market.
The main market on which Copy Trading was born and grew (due to its immense liquidity) was Forex Market, i.e. the foreign exchange market.
After that, with the advent of CFDs, almost all the other markets and their instruments joined the arena, including stocks, indices, commodities, interest rates, ETFs, and even Bitcoin.
Another fundamental element is the Broker, your ever-present companion. You can’t invest in almost any market without it.
With Copy Trading, you need a broker to get a trading account on which to receive, via the Copy Trading platform, the operating signals of the traders you have decided to copy.
Some brokers, however, are also Copy Trading platform themselves. The concept is the same. In any case, you must choose a broker (among those which support these services) and open a trading account (even demo).
Soon we will show you what the best options for Copy Trading are.
The Trader (or Signal Provider)
The Signal Provider is the trader you have decided to copy.
Obviously, you don’t choose which traders to follow sight unseen. Each platform allows you to observe and evaluate various data on the Trader’s operating performance.
There are various modes.
Some platforms require an evaluation of the strategy before allowing it, while others simply record the performance of the Signal Providers from the moment they subscribe, thus creating statistical data records for the users to consult.
The visibility of these data and their depth and accuracy, as we shall see, are some of the most important elements for a correct selection of the best traders to follow.
The investor (or follower)
This is, of course, your role.
Copy Trading is very flexible and can be used for many investment methodologies.
Each investor has his own objective and risk tolerance. Your job is to understand how to translate into practical and specific choices these two components: goals and risk management.
The InvestinGoal’s mission instead is to explain you how to do it best.
The Copy Trading platform
Last component, of course, is the Copy Trading platform, without which this would not be possible obviously.
Before the advent of these platforms, investors who wanted to benefit from the experience of other successful traders were using mailing list or chat rooms services, but, clearly, they were not automatic.
As we shall see, there are different types of Copy Trading platforms, each with its own characteristics, each with its own pros and Cons.
It is up to you to decide which one to choose according to your expectations.
Also in this case, InvestinGoal is ready to help you in this choice.
The replication process
As mentioned before, there are brokers who are Copy Trading platforms themselves.
However, for convenience only, to explain the signals replication process, we will refer to the condition in which the brokerage and copy trading services are managed by separate entities.
The Copy Trading platform is primarily concerned with two things with regard to the actual signal replication tasks:
- It acts as an intermediary between the Signal Provider broker and the investor Broker (it’s a broker of brokers)
- It handles the replication and propagation of signals from the signal Providers to the multitude of investors who copy them, according to the particularities of each one.
Imagine you have a $ 1,000 account, but you want to replicate a signal Provider with $ 100,000 account. His hypothetical 1% invested in a new trade is equivalent to your entire capital, and you obviously can’t afford to invest the same amount, otherwise one losing trade would be enough to burn your account.
For this reason, we need to proportionally replicate the trades of Signal Providers. The Copy Trading platform takes care of this.
Your job is to give them the necessary instructions, deciding the settings with which you want to replicate every trader.
- When the Signal Provider opens a new trade, his broker sends the data of the same trade to the Copy Trading platform
- The platform receives the data of the new trade
- The platform verifies who are the investors who are copying the Signal Provider, and the personal replication settings of each
- The platform sends to each investor’s broker the details for the opening of the new trade, but modified according to the client settings
- Each investor’s broker opens the order on its customer’s trading account
And this is all automatic.
And it happens in a few tenths of a second.
Same thing for the closure of the trade, or for a change in the Stop or Profit parameters.
The Signal Provider
In Copy Trading you can consider Signal Providers like the assets in your portfolio, and that’s why it’s often called a “People Based Portfolio”.
Each trader has its own characteristics and peculiarities, but there are some common categories under which we can categorize them.
The first category refers to the techniques used for trading, and we have:
- Those who use fundamental analysis
- Those who use indicators
- Those who use price action
Essentially, most of the time a trader specializes in one of these three categories, but he also has a basic understanding of the other two.
We can then group them according to the time horizons in which they operate:
- Long-term Traders (monthly or yearly horizon)
- Swing Trader (daily/weekly horizon)
- Day Trader (hourly/daily horizon)
- Scalper (seconds/minutes horizon)
Then, there are various factors you will need to pay particular attention to, for studying the strategy and the performance of the Signal Providers. Among the most important there are:
- How long he has been trading
- How many instruments he trades with (is he specialized on one or does he diversify with many?)
- How many positions he usually keeps open simultaneously
- How many trades he executes on average (per day, week, etc.)
- How long he keeps them open on average
- What’s the winning percentage
- What are the of Risk/Reward values
Investing in a Copy Trading strategy basically means to become a fund manager.
The fund is your, the capital is yours, and the manager is you.
You then have to decide what are the objectives of your fund, what risks you are willing to take, and then look for the best solutions to build it, i.e. the best assets.
In our case, your assets will be precisely the Signal Providers.
Many beginners make the mistake of thinking that the only important thing is finding the right traders, and that everything else doesn’t matter.
On the one hand, it is certainly true, but this is not enough.
Think at the above example, the Signal Provider with $ 100,000 account and you with $ 1,000. If you can’t reason properly, you risk of burning your account even by following the best traders.
The factors on which you need to focus on and to develop as an investor in copy trading are:
- Declaration of (plausibile) goals
- Recognition, analysis and management of risks
- Search and selection of Signal Providers
- Choosing each signals replication setting
- Implementation of the Strategy
- Portfolio management and monitoring
What are the risks
Copy Trading is a form of investment, we said that many times.
And as with any type of investment, you are putting your capital at risk.
Anyone who says the opposite, that there are no risks, is lying and is not in good faith.
Here are some of the risks you will be present with, and that you will be able to face.
Not knowing how the platform works
Let me tell you an episode actually happened to an investor.
Instead of taking the time to learn at least how the platform worked, an investor started immediately to replicate some Signal Providers.
The problem was that, because of the haste and inexperience, he thought he was replicating their trades with 10 micro lots, while in reality he was doing it with 10 standard lots.
This happened exclusively because he didn’t pay attention to the platform settings.
When he realized it, it was too late.
Not recognizing the risks of the Signal Provider’s strategy
I’m sure that many times you will encounter Signal Providers with stratospheric performance.
Perfect Equity Line, with no Drawdown, winning percentages close to 100%, steady profits every day.
Let me tell you right away. The strategies behind this type of performance are a mirage, and they hide a sure recipe for failure.
Those are strategies based on techniques such as price averaging down or even worse the Martingale. In the short term they may also give crazy results, but in the long run they are definitely not sustainable, and sooner or later they will face certain failure, and it will happen fast.
Not knowing how much capital to assign to each Signal Provider
You need to know how to allocate your capital on your different assets, i.e. on the Signal Providers, in order to maintain an optimal risk, minimize losses, and maximize profits.
Otherwise, you risk of giving too much capital to riskier entities, and less to the more virtuous ones.
Not controlling your portfolio
Copy Trading is not an activity that you simply set once, then you forget it, and you remember of it only when you want to cash your profit.
Obviously, it should not become a full time job either, as the Signal Provider one, otherwise it would lose its convenience.
The important thing is to find a balance, in order to constantly monitor the evolution of your fund, and knowing how to deal with adversities and how to react to them.
What are the best options
Now it’s time to give you the best resources to deepen the topic.
We can say that this post is a brief summary of our guide What is Social Trading (we called so for the reason I said at the beginning, but in essence it’s an extensive guide to copy trading, with 12 lessons).
There you’ll find all these topics treated more thoroughly, point by point.
Here, instead, there’s the link to find out what are the best Copy Trading platforms.
The top three are:
- eToro (for which we have also an eToro for beginners guide)
- ZuluTrade (for which we have also a ZuluTrade for beginners guide)
- ayondo (for which we have also an Ayondo for beginners guide)
I hope I was helpful in this mini Copy Trading guide.
What do you think about it?
Do not hesitate to write in the comments for any questions, concerns or just to tell us what you think.