Is Copy Trading a Viable Way to Invest?
The concept of social trading is nothing new in the global financial markets, enabling investors to observe the precise behaviour and trades of their peers to optimise their profits.
This underpins a large and fast-growing marketplace, which is expected to peak at a valuation of $3.77 billion by 2028. So, the sector will grow at a CAGR of 7.8% over the next five years, as a growing number of retail traders join the financial marketplace.
Copy trading is a subset of this market and one that’s also becoming increasingly popular. But what are the pros and cons of this methodology?
What is Copy Trading and How Does it Work?
As a subset of social trading, copy trading allows you to mimic the orders of other investors and leverage these directly to your advantage.
In this respect, copy trading is an extension of social trading, as instead of simply observing other traders’ investments to inform your own, it programs your account to replicate orders in real time.
This is a largely automated strategy and one that often copies individual trades from experienced or high-performance traders in the marketplace.
In terms of functionality, you’ll have first to choose an online broker that offers copy trading services. You’ll then agree to the site’s T&Cs before accessing a portal where you can analyse the performance and trades executed by experienced traders.
Once you’ve appraised these traders and selected your preferred option (you can also analyse trading strategies and rates of commission) before depositing funds and getting started.
What About the Pros and Cons of Copy Trading?
There are several advantages associated with copy trading, some of which are relatively overt. However, some potential drawbacks need to be considered, and we’ve broken these down in a little more detail below:
- Pro #1: Easy to Adopt: This is the single biggest advantage (especially for novice and inexperienced investors), as copy trading is incredibly easy to adopt once you’ve selected a reputable and successful trader.
- Pro #2: Diversify Your Returns: The best and most experienced traders are likely to have diversified portfolios, as this is central to optimising returns over time. So, copy trading provides instant and effective diversification for your portfolio.
- Pro #3: Drive Long-Term Gains: The traders you can copy each have their unique strategy, which may be short and long-term in nature. So, if you’d like to sustain gains over time, copy trading can be an extremely productive strategy.
- Con #1: Understanding Market Risks: Copy trading largely negates the need to think and strategise, but this can cause you to overlook key market risks in your trades. This can prove dangerous, especially if you copy higher-risk strategies that increase your exposure in the market.
- Con #2: Increased Liquidity Risk: This means that you may not be able to exit positions at the desired or expected levels. This is a significant risk with copy trading, so you must study a trader’s risk management techniques and identify historical precedence in this respect.
- Con #3: Master Traders Still Make Errors: Around 70% of forex traders regularly lose money, including master traders. So, you could still incur losses when engaging in copy trading, which may be disproportionate and could be compounded by your lack of understanding surrounding the marketplace.
