It is not often that new trends in stock trading trickle down from professional investment managers to the masses of everyday investors, but in recent years, a new phenomenon is grabbing the attention of traders of all types. Copy trading, born out of the rising practice of social trading, latches on to the concept of tapping into the power of the crowd at large for one’s own benefit, specifically in the arena of buying and selling securities. The popularity of copy trading has grown tremendously, as a number of brokerages and investment firms offer the ability to implement the strategy on their platforms. But as with any new trend, copy trading carries with it advantages and disadvantages that should be considered before jumping on the new investment bandwagon. Here, you can gain a better understanding of what copy trading is, how the process works, the winners and losers, and who benefits from copy trading.
What, Exactly, is Copy Trading?
Copy trading takes away some of the burdens inherent to becoming the next greatest financial trader by allowing individual investors to copy the trades of established relatively successful investors. For many potential investors, the idea of learning about the intricacies of stock markets, both domestic and foreign, is in and of itself a daunting task. Gaining knowledge about which companies are a strong bet based on their financial position, growth potential, or acquisition strategy can be challenging and, more importantly, time-consuming. Yet, the allure of making quick cash by correctly timing stock buying and the subsequent sell is a strong pull. Part of that is attraction is predicated on the somewhat elusive success stories that fill trading forums and online communities from the world’s best traders.
Through certain trading platforms, investors can select one or more stock traders to follow or copy. Linking your trading account to another investor means that your money follows theirs, including current positions within the market and the activities that follow. If a trader you are copying sells out of a certain position, so do you, without having to think about it or second-guess yourself. When copied traders win on their positions in the market, so do their followers; when they lose, the same is true. Copy trading effectively gives individuals with little time or little patience the ability to benefit from the perceived expertise of long-time traders, leaving the control in the trader’s skilled hands.
How Copy Trading Platforms Work
Copy trading is done on select trading platforms that cater to this new trend in stock investing. Through a copy trading platform, the specifics of how trades are placed or traders are copied can vary slightly, but the basic principles remain intact. The first step is to create an account through a copy trading service and fund it with the amount of money with which you feel comfortable investing. Most copy trading platforms come with a minimum investment amount, but that is often relatively low. Once a trader has successfully created an account and added funds, they are free to copy any trader whom they feel has an impressive track record or carries investments that intrigue the copier. With most copy trading platforms, the ability to copy a trader is as simple as clicking a button on the screen. The positions held by the copied trader are automatically placed into the copier’s portfolio, and gains and losses are mapped over as they take place within the original trader’s portfolio.
Given the risk of investing in stock positions and broad markets, copy trading does come with a few limitations. Most copy trading platforms limit the extent to which an entire account balance can be invested in a single trader’s copied portfolio. For instance, a trading platform may only allow one to invest 20% of his portfolio with a copied trader; all in an effort to promote diversification in investments while limiting the downside risk should the copied trader make losing trades in any given period. All trades are copied into the investor's account at the same rate as the original trader, and to make things simple, the entire process is automated within the platform, so no calculations need to be made on either end of the transaction.
When traders are satisfied with the investments selected by the traders they follow, most platforms allow for adding funds in an attempt to increase profits. Taking this step, however, increases the risk of losing should the trader make a wrong move. Reducing funds is also available within copy trading platforms if the copied trader is not performing up to par. Some platforms offer more control than others when it comes to individual trades, giving an investor the ability to close a position manually even if the copied trader keeps it in his portfolio. Other platforms only allow investors to unfollow a trader to reduce losses or move on to another portfolio. It is important to review the copy trading platform’s specific rules prior to investing.
The Winners and Losers of Copy Trading
The practice of copy trading has grown increasingly popular among everyday investors, and the majority of platforms that offer copy trading as an option have made the process relatively simple, even for those with no trading experience. One of the ways copy trading is made easy to traders who make themselves available to be copied provide the historical performance data. Copy trading platforms publish the track record of investors so that new traders can make informed decisions on how much or how little to invest in a specific trader’s portfolio. Unfortunately, markets can change suddenly, and trades can be ill-timed, leaving both the copied and the copiers with realized losses within their investment accounts.
Copied traders receive a commission when they allow their trades to be Copied by other traders, which vary depending on the platform used for trading. Copiers may pay a small fee either to the platform or directly to the copied trader for access to their expertise and skill, ultimately reducing their total earnings from profitable trades. Overall, both copy traders and the investors copied stand to benefit from the process, and both parties stand to lose when trades are placed at a loss.
The Benefits of Copy Trading
The most apparent advantage to copy trading is the ability novice investors gain in accessing the markets in a controlled, knowledgeable manner. There is no need to spend a significant amount of time learning about how markets work, how companies grow and contract, or how to select the cream of the crop as it relates to investments. Instead, with a simple click of a button through a secure online platform, investors have access to hundreds of expert traders who have been around the investment block. Copy traders also have unrestricted access to the performance track record of their chosen traders, providing more insight into what may be down the road in terms of their own profits or losses.
In addition to offering a seamless way to invest at a high level, copy trading takes away some of the fear associated with the unknown. Investors new to the game have no need to analyze complex charts or graphs to determine when to buy and when to sell – activities that drive panic and trepidation in the trading universe. Investors can begin trading immediately, based on the knowledge of others, and in some cases, copied traders provide expert tips on how to start picking investments on one’s own in the future.
Given that copy trading platforms force investors to break up their portfolios among various copied traders, diversification becomes another advantage inherent to the process. Copy trading platforms limit how much a single investor can copy another trader’s portfolio, meaning there is a need to spread out investments among various traders or other selected investment positions. This built-in diversification helps reduce the potential for loss across the board and provides a peace of mind that may not be easily obtained when investing on one’s own.
Individual investors who make the decision to copy expert traders also benefit in terms of time spent on monitoring a portfolio. Selecting individual stock positions, carefully watching each investment’s movement throughout the day, and lamenting over when to buy or sell is an all-encompassing job. Copy traders can simply invest their funds in a copied trader’s portfolio and walk away. When profits (or losses) are realized through trades, investors see those movements credited to their account in real- time, and there is no need to check on the progress of investments continually.
Copying trading can be a beneficial strategy for individuals who are new to trading or those who simply do not have the time or energy to select, monitor, and act on trades each day. The growing number of copy trading platforms makes it easy to get started with a trading account and find traders to copy in a matter of minutes. There are built-in safeguards against losing it all, like limits on how much one can copy a single investor or position, but copy trading still carries risk. Before starting down the copy trading road, get comfortable with the fact that the money invested could be eaten up by losses quickly and that while overnight success is possible, it isn’t the norm.
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