For retail investors, and particularly those who choose to trade as an extra-curricular activity away from their day jobs, stock market trading can feel like a closed shop. So, could copy trading offer unprecedented levels of accessibility as well as profitability?
The challenges of trading have generated some stark statistics in recent years. According to a report from trading platform Capital.com, not only do 70% of DIY investors lose money, but during an 18-month period ending in July 2021, 70% of trades executed on the platform were closed within 24 hours. Additionally, 45% of trades were closed within 60 minutes.
The report also states that losing positions were closed 1.4 times more frequently within five minutes than winning ones, illustrating the severe difficulty surrounding the trading landscape.
It’s for this reason that the appeal of copy trading is clear. In identifying a successful trader and mimicking their strategy, investors of all competencies can rest assured that a more experienced market entity is making decisions on their behalf.
But is copy trading all it’s cracked up to be? Let’s explore the opportunities and risks associated with following the decisions of other traders:
Mixed Results in Volatile Markets
Before we look at the pros and cons of copy trading, it’s worth asking whether this investment strategy actually works. The answer tends to be ‘yes, sometimes’.
Using the trading performance of leading copy trader platform, eToro, around the time of the pandemic, Financial Times data showed that over the long term the most popular registered traders outperformed the S&P 500 with relative comfort.
Traders known as JeppeKirkBonde, CPHequities, and rubymza all outpaced the S&P 500 between March 2017 and September 2021, with JeppeKirkBonde recording more than double the returns of the index.
However, the data also showed that the post-pandemic stock market boom period left eToro’s most popular traders flat-footed, with all three underperforming the index throughout 2022 and much of 2023.
This indicates that copy trading can produce mixed results when market volatility is high. The likes of JeppeKirkBonde, CPHequities, and rubymza all appeared to struggle amid 2022’s tech-stock sell-offs, which may point to the users’ collective risk appetite leading to larger losses in comparison to the S&P 500.
Despite the varied fortunes of popular copy traders amid challenging market conditions, there are still many benefits that copy trading can offer retail investors seeking exposure to stocks and shares.
Adaptable Risk Management
Risk plays a major role in successful copy trade strategies, and for retail investors, finding the right trader that suits their risk appetite can be a great formula for managing expectations and seeing the desired performance metrics.
Fortunately, many copy trading platforms provide risk management tools for investors to mitigate the risks associated with copying trades. Tools can involve stop-loss and take-profit orders, both of which allow investors to secure profits at the levels they choose and retain control over their portfolios.
Analytical data can also help when selecting traders to copy, and long-term performance metrics can be a good indicator of the level of risk each trader looks to take on. However, it’s important to always remember that past performance is never a guarantee of future results.
Learning from Skilled Traders
Another advantage of copy trades is that investors can learn how to trade stocks by forming connections with their chosen traders and their investment journey. The obstacles they’ve overcome to improve can offer some inspiration for shaping future goals and strategies.
In achieving a broader knowledge of successful traders, retail investors can shape their respective journeys. It’s also possible to use copy trading to identify the best-aligned traders and view their autobiographies to learn valuable lessons and perspectives for learning how to trade stocks.
Misleading Metrics
On eToro’s website, a stark warning over copy trading risks claims that “there are frequently sharp differences between hypothetical/past performance results and the actual results subsequently achieved by any particular trading program.”
This can be one of the biggest issues that retail investors face when embarking on their copy trading journey. Markets are fluid, and the trader topping the leaderboards today, yesterday, or over the past 90 days is in no way guaranteed to remain a top-performing trader tomorrow.
Performance metrics can mask viable trading strategies and cause retail investors to place their faith and portfolios in the hands of someone who could be about to embark on a losing streak.
The use of leaderboards for copy traders can be important to identify high-performing users, but it can also perpetuate the hot-hand fallacy of believing that someone who has had three profitable months is more likely to post a fourth without any supporting logic.
Markets Don’t Care About History
Of course, another issue is that the stock market doesn’t care about past performance for traders, and anybody could be in line for a drawdown with little warning.
While there are protections against market risk for retail investors, losses can still compound when following the trades of others.
With many established copy trading strategies involving following trending markets, it’s possible that investors could access diminished returns that have already been eaten into by other, faster traders. This could mean that an unexpected reversal in fortunes can particularly impact copy traders following a riskier strategy.
Maintain Due Diligence
While it can be tempting for traders to set up their copy strategy and leave their account for prolonged periods, it’s imperative that retail investors continually monitor their market performance and update their stop-losses to ensure that they’re in line with their trading goals.
Markets can change fast, and so can the performance of traders. When something is consistently failing to reach expectations, it could be worth revising an approach entirely rather than blindly chasing a market recovery.
Most importantly, it’s vital that copy traders remember their investing goals. Hot hand fallacies can lead to high expectations, but taking profit at the right time is the cornerstone of a sustainable trading strategy.
Disclaimer: This article contains sponsored marketing content. It is intended for promotional purposes and should not be considered as an endorsement or recommendation by our website. Readers are encouraged to conduct their own research and exercise their own judgment before making any decisions based on the information provided in this article.
