The rise of social media has found its way into finance with copy trading – also known as social trading, mirror trading or auto trading. Copy trading has become an increasingly popular strategy among retail investors.
But despite its growing popularity, it comes with inherent risks that you should consider before trading.
We've prepared this guide to help you decide if copy trading is right for you.
What is copy trading?
Copy trading has become a popular way to earn an income in the financial markets, as it allows you to copy the moves other traders are making in various markets.
Most famously used in share trading, it has now spread across to crypto, forex and contract for difference (CFD) markets, with various brokers offering copy trading features.
Born out of mirror trades in 2005, where traders would copy automated trades, copy trading continues to gain popularity as it is an effective way for new investors to gain access to markets and learn new ways of investing. After all, if you don't understand how markets work but want to grow your money, putting it in the hands of someone else who knows more sounds prudent.
While copy trading might take the pressure off you when it comes to trading, it is important to know you'll only be as good as the trader you copy. Choose the wrong person to copy and you could lose.
How does copy trading work?
Copy trading through a broker that has this feature is incredibly easy to do.
When you sign up to a copy trading platform, you'll be able to scroll through various investors that you can copy. You should try to pick an investment option based on your personal risk tolerance and time frame.
After finding the right person to copy, you will need to select an amount to initially invest and how much you want to add when the person you're copying takes out a new position. From there, your broker will do the rest.
When choosing a copy trading strategy, you'll need to choose from a variety of features, including the following:
- Trade entry. When the person you are copying takes up a new position, you can set your portfolio to automatically buy into the new position.
- Take profits. Some brokers will allow you to set your portfolio up to automatically sell should it grow by a certain percentage. This will allow you to guarantee profits.
- Stop loss. Should the portfolio fall, you can set it up to automatically sell, protecting yourself against losses. However, this will mean you're guaranteed to lose because you will sell when the price falls.
The alternative to copy trading through a broker is copy trading through a subscription or revenue-sharing model.
In this instance, you can sign up to a subscription and get share ideas sent to you, usually on a monthly basis. This again takes the guesswork out of investing. However, this process is a more manual one where you will need to physically buy and sell all the shares yourself.
Who should you copy?
Deciding on who to copy is one of the most important considerations when it comes to copy trading, due to their performance ultimately determining your financial position.
While you might be tempted to choose a trader who is on a hot streak, it is important to look a little deeper.
You should try to find someone who has a long track record of solid performance, while also finding someone that aligns with your personal investing time frames, values and risk tolerance.
What providers offer copy trading?
There are numerous brokers that offer copy trading features. Before signing up to one, you should have a basic understanding of what financial products you want to copy as their offerings will differ.
To help get you started, here are 5 brokers you could consider:
- eToro. Copy trade shares, CFDs, forex and crypto.
- ZuluTrade. Trade forex, cryptos, commodities and indices through its copy feature.
- AvaTrade. The broker allows you to copy trade forex, CFD and cryptocurrency products.
- Pepperstone. It allows retail investors to choose 3 third-party services: MetaTrader signals, DupliTrade and MyFxBook. These products allow you to trade forex and CFD products.
- Axi. Trade 140 forex pairs, precious metals, commodities, indices and cryptocurrencies.
Is copy trading legal?
While it might not seem like it, copying other investors' trades is legal and is a legitimate way for investors to make money.
Copy trading is legal in most countries with regulations falling on the broker within each country to remain up-to-date on their licensing. In Australia, there are no laws that prohibit copy trading. However, if the broker isn't regulated, it quickly falls into illegal territory. This is to help protect newer investors and to make sure they don't lose money through dishonest traders.
How copy trading can benefit you
Copy trading has numerous benefits, but perhaps the most important one is that it simplifies investing.
The following are some of the benefits of copy trading:
- Allows you to trade with industry professionals
- Takes the pressure off your individual decisions
- Allows you to learn from other investors
- Gives you immediate diversification when you copy a portfolio
- Allows you to diversify into asset classes, including shares, forex CFDs and crypto
What you should watch out for
While there are certainly some benefits to copy trading, it is important to highlight the potential downsides of copy trading:
- You aren't in control of your own financial position. After all, you're following someone else's portfolio.
- You need to find someone with similar risk tolerances and time horizons as yourself.
- You might not want to invest in all assets that you're copy trading.
- Copy trading costs money. Through either a subscription, revenue sharing model or even a trading fee, you'll pay for the service. Remember, lower fees can help with overall performance.
Disclaimer: This information should not be interpreted as an endorsement of futures, stocks, ETFs, CFDs, options or any specific provider, service or offering. It should not be relied upon as investment advice or construed as providing recommendations of any kind. Futures, stocks, ETFs and options trading involves substantial risk of loss and therefore are not appropriate for all investors. Trading CFDs and forex on leverage comes with a higher risk of losing money rapidly. Past performance is not an indication of future results. Consider your own circumstances, and obtain your own advice, before making any trades.