Copy trading or social trading consists of carrying out trading strategies by copying expert operators, usually through social networks.
We are facing a type of investment strategy based on following specialists in the sector. In this case, what we do is establish a series of strategies that copy those of the experts that we decide to follow.
For example, when a certain investor buys at a floor price, we will too. In this way, when the time comes, he will execute the order and so will we, since if he wins, we win.
History of copy trading
One of the first tools to be able to do copy trading were the newsletters of large investors. In this way, the information they provided allowed beginners to copy the most successful strategies of the moment.
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The Internet revolutionized the financial world in the 90s, making it possible to find quote data in real time. In addition, the news about successful investors encouraged many people to copy their strategies.
With the appearance of algorithmic trading, in 2005, copy trading and mirror trading arose, which allowed automated monitoring. One of the first to offer it was Tradency with a system called Mirror Trade that allowed experts and other users to copy.
In this way, the operations were included in a commercial history that allowed others to perform them in an identical way. Since 2010, this way of trading has grown, helping less experienced traders learn to invest.
Forex (currency market) was one of those that executed a greater number of operations using this type of trading. Being very volatile, advice and experience were considered very valuable.
Of course, financial education was also essential for the investor, since part of the decisions had a personal and subjective aspect. But this is still valid, no matter how much we follow an expert, it is convenient to have basic knowledge of economics and finance.
Advantages of copy trading
Let’s see some of the advantages of this form of trading:
- First of all, it allows less experienced people (copiers) to learn from those who know more (signal providers). Thus, knowledge and experience are shared with other investors who use it to their advantage.
- By creating a community of traders, financial knowledge spreads throughout the world and this allows for better investments.
- Virtual reputation is key to the user’s choice of whom to copy. And this must be formed, as various studies conclude, by a rational part, based on the returns obtained by copying, and an emotional part, based on intuition.
- A system of qualifications and incentives helps beginners to follow the strategies of the leaders. In this way, some offer this attraction for traders to follow them.
Disadvantages
On the other hand, we have the disadvantages of this type of trading:
- Experts are not always right, this is impossible. Therefore, regardless of your knowledge and experience, the risk of losing money exists.
- There are times, such as when there is a panic in the markets, when the majority opinion of the community is not the most appropriate. You have to watch these moments and be prudent in your decisions.
- Emotions, reputation or being liked is one thing and profitability is another. For this reason, we must take into account the rational aspects and we must carefully analyze the professional profiles to be copied.
- Past performance is not a guarantee of future performance. While success is a good indicator, it requires other more difficult-to-measure attributes.
- Incentives can promote wrong strategies with the aim of modifying the market in the interest of a few. Here the maxim that easy money does not exist is valid.
Steps to copy trading
Let’s see what steps it is advisable to follow to carry out copy trading.
- First of all, we need to select the right signal provider. As we have already mentioned, we will seek a balance between emotional and rational intelligence. In addition to being successful, you also demonstrate your knowledge and experience.
- Choose the right platform. This is an essential step and here, once again, we will focus on reputation and, above all, on the tools that are available to us.
- It is convenient to be clear about what we are looking for, to copy the right provider. Once we have the list of them, we must know what our priorities and our investor profile are in order to choose the reference that best suits us.
Studies on copy trading
We are going to see various studies carried out on this trading technique and what their main conclusions were in this regard:
- In 2012, MIT funded one that found that those who followed signal providers made 4% more returns than those who invested independently. Therefore, imitation had an important role.
- In 2014, Mauro Martino, from IBM, showed that investments based on copying the experts were more fruitful, although the return on investment was lower than in regular successful operations.
- In 2019, Gortner and Van der Weele observed in the double auctions of Arrow-Debreu securities that copy trading allowed them to create less volatile portfolios.
- These same authors (Gortner and Van der Weele) discovered a willingness effect between the copied and the copiers. This consisted of carrying out operations to obtain profits based on what these copiers did, in short, it was about copying the copier.
Example of copy trading
Let’s imagine the situation experienced in the world with the COVID-19 pandemic. Several savers made the decision to invest to obtain some profitability. Some of them decided to “copy” experts, not having much financial knowledge.
Some used one of the best-known platforms that allows us to choose the expert we will follow. In it, they offer us the possibility of choosing among a group of investors, based on certain metrics. In the example, we opted for a minimum accepted return.
Now we copy their strategies. If you buy shares of a certain company, we will give the order to do the same. In addition, it allows us the option of limiting the maximum amount to invest or, in this case, said minimum return.
In this way, with automated copy trading, when we reach a certain situation, an order will be executed automatically. As it may be that the profitability falls below 5%, the order to stop copying that trader is activated. In this way, we will avoid possible losses. The image shows the process:
