What Is Copy Trading? 

Copy trading is a portfolio management strategy where one copies the trades of another trader, tracking the performance of that investor. There is also an automated version of copy trading where one’s trades are automatically transacted. A manual version will allow a trader to execute their own trades. 

Copy Trading: 3 Key Components: 

• Provider: 

 This is the trader whose trades are being copied. They are sometimes also referred to as the “master trader” or “signal provider”. 

• Copier:  

This is the individual who copies the provider’s trades, using their own trading account. 

• Broker: 

 The broker facilitates access to the copy trading platform (such as the app or Meta Trader 4), which enables the connection between the provider and the copier. 

How Does Copy Trading Work? 

• Open An account: 

To start copy trading, you will need to open an account with a broker that offers this service. 

• Choose the trader: 

 Once you have opened your account, you will select the traders whose trades you would like to copy. This is usually done by browsing through the broker’s list of available traders. 

• Specify the capital: 

Once you have chosen a trader, you will specify how much capital you would like to allocate to their portfolio. You can also set your own risk parameters, such as the maximum loss you are willing to take on a single trade. 

• The broker part: 

With the copy trading account you have set up, the broker will automatically copy all trades made by the trader you are following. This means that whenever the trader you have selected opens or closes a trade, your account will automatically reflect that action. 

Advantages and disadvantages of copy trading 

Advantages of Copy Trading 

• Learning from experienced traders: It is an excellent way for beginner traders to learn. By copying a trader, you essentially benefit from their experience and skills. This can be invaluable for understanding the markets and developing your own trading strategies. 

• Passive income potential: It can be a passive way to generate income. Once you set up your copy trading account, no further action is required. The broker automatically replicates all the trades made by the trader you are following. This allows you to make money while you sleep or work. 

• Portfolio diversification: Copy trading allows you to invest in the portfolios of multiple traders. This is a great way to diversify your portfolio and mitigate risk. 

Disadvantages of Copy Trading 

• Investment risks: It is not a risk-free investment. Even when copying a successful trader, there is always the risk of losing money. 

• Lack of strategic understanding: You may not understand the strategies used by the trader you are following. Thorough research is crucial before copying a trader to understand their trading strategies and risk parameters. 

• Limited trade control: You may not have control over individual trades once you start copying a trader. This means that you are limited by the trader’s performance until you stop copying them. 

How to Choose the Best Trader? 

When choosing a copy trading platform, there are several factors to consider: 

• Regulatory compliance: Make sure the platform is regulated. This means that it is supervised by a financial regulatory body, such as the Securities and Exchange Commission (SEC) in the United States. 

• Trader diversity: Choose a platform that offers a wide selection of traders to copy. This provides more options and allows for portfolio diversification. 

• Fee comparison: Compare the fees charged by different platforms. Some may charge a commission per copied trade, while others may use a monthly subscription model. 

Copy Trading vs. Mirror Trading 

Despite their similarities, copy trading and mirror trading have subtle distinctions.  

Mirror trading is defined as the replication of a trading strategy. Traders emulate the trading style or strategies of other traders. Initially, interest focused on specific algorithms developed by developers who shared their trading history. Traders, identifying algorithms with strong returns, would replicate their results, asking the developers for permission to follow their strategies. Copy trading evolved from this practice of mirror trading. 

However, in copy trading, the basic structure of the copied trader’s strategy remains undisclosed. 

Instead, followers blindly replicate the trades that the trader executes. 

Social Trading Vs Copy Trading 

Social trading and copy trading share a common core, but they are two different concepts. 

Social trading is the broader term, which includes copy trading as a subset. This relationship is the source of much confusion. While copy trading is a form of social trading, social trading is not all copy trading. Social trading allows you to leverage information from other traders to inform your own decisions, but ultimately, you retain control over your trades. You decide when to enter or exit a position. 

Copy trading, by contrast, is a strictly automated form of social trading. It links your account directly to another trader’s account, mirroring their trades in your own portfolio. Their gains become your gains, and their losses become your losses. You give up direct control over individual trades; the process is automated. While some platforms offer limited management capabilities, others restrict you to simply starting or stopping the copy process. This automated mirroring is the defining characteristic of copy trading. So, while copy trading falls under the umbrella of social trading, the term “social trading” itself refers to the broader practice, which is different from the automated repetition of copy trading. 

What to know before Copy Trading? 

While copy trading is automated, it is extremely important to evaluate the strategy provider you are following. You need to determine if their trades are based on a sound, repeatable, and ultimately profitable approach. 

What does this entail? 

• First, trades must be executed based on a proven trading plan or strategy. Successful traders develop a plan and stick to it, even during losing streaks, because they trust its long-term effectiveness. 

By observing the activity of a professional trader, you will begin to recognize patterns. A consistent and effective pattern indicates that the trades you are copying will likely be profitable. 

• Second, trades must be repeatable based on reliable setups. For example, a trade may be triggered by an uptrend and a double-legged moving average (MA) pullback. If this price action is repeated, you should be able to replicate the trade. 

Of course, profitability is paramount. While not every trade will be profitable, the overall performance should be profitable. 

Keep a trading log to track and review your trades. It is extremely important to focus not only on the outcome, but on the rationale behind each trade and its replicability. 

Example of Copy Trading 

Let’s illustrate copy trading with an example. Imagine a domestic market crash in Brazil, and you’re looking to gain exposure to the Brazilian Real. If you feel you lack sufficient knowledge of the Brazilian economy, politics, or central bank policies to make informed decisions, you could benefit from copy trading and the expertise of a trader who is familiar with these areas.  

At the same time, you may be aiming to gain experience and skill in a market that you wouldn’t normally have access to.  

However, before allocating real capital based on the advice of another market participant, it’s crucial to conduct your own due diligence – even if you’re not familiar with the underlying market.