Advantages And Disadvantages Of Copy Trading

Traders can collaborate with peers with the same interests, exchanging mutually beneficial trading related information.

The Internet 2.0 brought about social shift. Instead of many listening/watching THE “expert” in a hub-spoke relationship, apps like Twitter or Stocktwits empower traders to “tune in” to what they’re really interested in.

Instead of watching CNBC “experts” (!), traders can collaborate with peers with the same interests, exchanging mutually beneficial trading related information. One approach is copy trading, whereby “Leaders” publish live trades that “followers” copy. The copy-trading promise is for experienced operators to help novice traders learn and profit faster.

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How to gauge whether this promise holds?  By testing the incentives of all involved!

Novice traders can undoubtedly gain from watching a master at work – incentives checked. What, however, does it take for accomplished traders to let anyone watch over their shoulder?

Winning consistently requires talent and hard work. Knowing what consistent winners do at any point in time is valuable information: what wouldn’t you pay to know how Soros´ Quantum Fund is positioned any time? More importantly – what would George demand in exchange?

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Right. George would NEVER tell you for free, because once you knew, you would replicate the Quantum Fund at no further charge. Which means: good traders allowing you to copy-trade will demand compensation. The reverse also holds: only bad traders will let you copy for free – which defeats the purpose!

This begs two further questions: WHO and HOW pays trade-leaders?

As to the who, the copy-trader himself and his broker are the only suspects.

Followers can pay a lump sum (e.g. a signal subscription fee) or a share in copy-profits. Smart leaders won’t profit-share, because once they disclose trades they can’t reliably monitor follow-profits… what stops followers from copy-trading brokerage accounts hidden from the leader? Lump sum is also problematic… given few pay more than hundreds of dollars for signals/EAs; what is the incentive to publish insight, powering millions of profits not shared with them?

How about leader paying brokers? Again, test incentives! Brokers charge followers spread/commissions, so leader´s pay traces back to follower spread/commissions! Wouldn’t such brokers likely charge followers higher spreads? Will they resist the temptation to favor trade-leaders that generate high follow-commissions… above those just focusing on profits?

To answer whether copy trading is a good or a bad thing, use these 4 rules.

  1. Stay away from “free” trade leaders – they can´t be worth copying!
  2. If not paying the trade-leader yourself, test your broker´s goals. You´re looking for profits, but might be lead for commissions!
  3. Don’t expect much more profit out of a signal service/EA than your fee. Would you give away millions in profit for USD hundreds per month?
  4. Paid trade-leaders provide investment advice. Check their regulatory status & distrust unregulated providers – genuinely good traders don’t take shortcuts!
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