If you want a portfolio that matches the performance of investing pros, copy trading may help. In a nutshell, copy trading emulates a stock market expert’s trading activity. But there are pros and cons to this approach. Here’s what copy trading is, how it works and what you can expect from it.
Copy Trading Definition
Copy trading is more or less what it sounds like. You choose an expert trader to follow, then copy their trading movements. Say trader you’re following buys 100 shares of a particular stock. As a result, you’d also buy 100 shares of that stock. If they allocate 5% of their portfolio to a specific stock sector, you’d do the same.
The key is choosing a trader to follow whose investment style and goals align with yours. For example, if you invest conservatively then you’d copy someone with a conservative trading bent. Likewise, if you’re a growth investor then you shouldn’t match the trading activity of a value investor.
You can do copy trading on your own or through a copy trading platform. The latter allows you to select a trading activity to mimic. Meanwhile, it makes investments for you. Trades happen automatically so there’s very little you have to do. However, you still choose which investor to follow. Also, make sure there’s enough money in your trading account to cover trade activity.
Advantages of Copy Trading
Copy trading creates opportunity to leverage someone else’s investment knowledge and experience. You don’t have to analyze stock market movements or trends to decide which stocks to buy, sell or hold. You can simply follow a pro investor. Say you’ve picked someone who consistently generates high returns in their portfolio. As a result, copying them would theoretically allow you to do the same.
Copy trading is largely passive. You’re leaving the hard work of choosing investments up to someone else. You can earn returns in your portfolio without having to invest hours researching the market. Diversification and risk management are also done for since the pro trader is the one directing investment decisions.
In terms of how to choose an investor to emulate, there are a few criteria to consider:
- How long they’ve been trading.
- Investment track record.
- Number of open positions.
- Typical holding time for investments.
- Preferred types of investments.
You should also look at what you want to do with your portfolio. For example, if seek more alternative investments, you may copy someone who focuses on hedge funds, commodities or FOREX. On the other hand, if your goal is to match the performance of the market rather than beat it, you might lean toward a professional investor who prefers an index strategy.
Copy Trading Cons
There are arguments for copy trading. However, it may not be right for every investor. There are a few important things to keep in mind before you get started with this strategy.
First, your success hinges on which investor’s movements you follow. No investor is perfect when it comes to knowing when to buy or sell or where to invest. Consequently, copy trading involves a certain amount of risk. You’re hoping the pro trader strategy delivers maximum returns. But there are no guarantees.
This is where you have to spend some time researching traders. Learn more about how they operate and whether their methods align with your goals. Picking a trader at random could backfire if their strategy is completely different from what you’ve done with your portfolio
Copy trading could also be expensive if you’re paying commissions for frequent trades. If you’re using a copy trading platform to manage your portfolio for you, then you may also pay management or administrative fees to the platform. If you’re concerned about keeping fees low, then carefully consider the costs before trading.
Mirror Trading: A Copy Trading Alternative
Mirror trading is similar to copy trading but it’s not exactly the same. You could think of it as “copy trading lite.”
With this strategy, instead of replicating an investor’s movements trade for trade, you’re mirroring their overall investment style. So, say you’re interested in investing for value. In that case, you might choose to mirror Warren Buffett’s investment style. You may not necessarily buy every investment he does or every investment he recommends. But you’d base your investing decisions on the same principles he follows.
Mirror trading still allows you to benefit from the expertise and knowledge of another investor. But you may not hold the same investments they do. Instead, you apply a strategy that’s been successful for them to your own portfolio. Hopefully, you’ll achieve a similar measure of success.
The Bottom Line
Copy trading is just one way to automate your investment strategy. It takes the guesswork out of choosing where to invest your money. However, it may work better for some investors than others. Knowing the risks and reward potential can help you decide whether copy trading is a strategy you should adopt.
- Consider talking to your financial advisor about the pros and cons of copy trading and whether it’s something that might be worth trying. Your advisor can help you decide what copy trading can or can’t do for you and whether mirror trading might be a better option. If you don’t have an advisor yet, finding the right financial advisor that fits your needs doesn’t have to be hard. SmartAsset’s free tool matches you with financial advisors in your area in 5 minutes. If you’re ready to be matched with local advisors that will help you achieve your financial goals, get started now.
- If you’re looking into a copy trading platform, take time to learn which securities you can invest in. For example, some platforms may allow you to copy trades for a range of investments while others might limit you to FOREX or commodities.
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