What is Copy Trading and How Does it Transform Investing?

Copy trading is increasingly becoming popular with retail clients. In simple terms, copy trading allows you to ‘mimic’ an expert trader. So, if the trader goes long on Bitcoin and makes 5% gains, you’ll replicate the same outcome. 

This copy trading guide explains everything you need to know. We explain how copy trading works, what benefits and risks to consider, and which platforms offer the best service. 

What is Copy Trading? 

Let’s start with the basics: What is copy trading?

In a nutshell, copy trading is a passive investment tool. It enables you to buy and sell assets without lifting a finger. As the name suggests, you’ll be ‘copying’ another trader. In theory, you’ll be copying a professional investor with a proven track record. This means you can replicate the same orders from the comforts of home. 

This makes it a win-win outcome for both parties. From your perspective, you can copy a professional trader passively, allowing you to sit back and mimic their success. From the trader’s perspective, they’ll earn additional income on top of their own trading activities, usually via a profit-sharing agreement. 

Before proceeding, let’s look at a quick example of how copy trading works:

• You invest $2,500 into a copy trader.
• The copy trader places their first trade. They risk 10% of their portfolio on a GBP/USD long order. 
• You also invest 10%, so that’s $250 (10% of your $2,500 investment). 
• A few days later, the GBP/USD position is closed at a 5% gain. 
• On that trade, you risked $250. So, 5% gains amount to $12.50. 

The above example shows that you made $12.50 gains without any input. The trader you copied did all of the research on GBP/USD. They also placed the required entry and exit orders accordingly. You simply sat back and watched the action unfold. 

Copy Trading Pros and Cons 

Copy trading comes with the following pros and cons:

How Does Copy Trading Work? 

Copy trading is just one type of automated investing. Therefore, it’s important to know whether copy trading is right for you before proceeding. 

This section takes a much closer look at how copy trading works. 

Copy Trading Integration

First, let’s explore how copy trading integrates with your brokerage platform. After all, there are many different ways to set up a copy trading account. The most common option is to use an online broker that directly offers copy trading services. 

eToro – one of the pioneers of copy trading, is the best-known option. It offers a regulated trading platform for thousands of assets. Users can copy any trader of their choosing from just $200. This means all trades are executed in-house, meaning there’s no requirement for third-party integration. 

In most other cases, you’ll need to connect at least two different platforms to get started. For example, MT4 and MT5 are popular for copy trading. These are third-party trading platforms that connect to hundreds of brokers. So, you’d be copying traders on MT4/5, and the respective orders are executed with the connected broker in real-time. 

Choosing a Copy Trader

The most challenging part of the process is knowing which trader to copy. Most copy trading platforms offer filters, allowing you to narrow down the search based on your preferences. 

We offer a much more in-depth explanation of this further down. 

For now, let’s cover the key points:

• Type of Financial Instruments: You’ll need to choose a trader that specializes in your preferred financial instruments. For example, crypto, forex, stocks, indices, or commodities.  
• Track Record Length: You’ll want to focus on copy traders with an extended track record. Otherwise, their statistics will be skewed. We’d suggest avoiding traders with a track record of under 18 months. 
• Monthly Performance: Explore how much money the copy trader has made or lost every month since joining the respective platform. Look for trends and compare this to the broader market. For example, how does the trader perform in bear markets?
• Return on Investment: Assess the overall return on investment made by the trader. This is the total percentage gains since the trader started. How does the return on investment compare with the market average over the same period?
• Maximum Drawdown: A very important figure, the maximum drawdown shows the largest bankroll drop from its peak before it recovers to new peaks, in percentage terms. A high maximum drawdown shows that the trader might not be risk-averse.
• Risk Rating: Some copy trading providers automatically assign their traders with a risk rating. This can help you assess how much risk the trader generally takes. There should be a direct correlation between risk and returns.  
• Average Trade Duration: The average trade duration (ATD) ensures you select a trader that aligns with your preferred strategy. For instance, an ATD of 3 hours would suggest an intraday strategy is being deployed. An ATD of 20 days would suggest a swing trading strategy.  

.

These are just some of the metrics to consider when researching copy traders. Naturally, you reduce your risk by diversifying. This means spreading your investment funds across multiple traders. 

For instance, suppose you have $2,000 to invest. Your chosen copy trading platform has a minimum investment requirement of $500 per trade. This means you could invest in four different traders. 

Investing Proportionate Amounts

When it comes to investment stakes, copy trading works on a proportionate basis. Two metrics determine how much you automatically invest on each trade. 

• First, the amount you invested into the copy trader.
• Second, the amount of capital the trader risks on a specific position. 

Let’s clear the mist with a reliable example. 

• We’ll say you invest $2,000 into a crypto copy trader. 
• A few hours later, the crypto trader enters their first position – they go short on BTC/USD. 
• The trader risks just 3% of their portfolio on this trade. 
• So, as you invested $2,000 into the copy trader, you’ve automatically risked $60 (3% of $2,000) on the BTC/USD short position. 

Now let’s say the trader closes the BTC/USD short position at a 20% profit. 

• As soon as the trader closes their position, it’s automatically closed in your account.
• The crypto trader made a 20% profit. So, you risked $60 on this trade, meaning a profit of $12.
• Had the trader lost 20%, you would have lost $12. 

The proportional system ensures that copy trading is affordable for all skill sets. However, you’ll still need to meet a minimum investment requirement. For example, eToro requires users to invest at least $200 per trader they copy. Some platforms have even higher minimums. 

Benefits of Copy Trading

Still not sure if copy trading is right for you? The benefits of copy trading are discussed below. 

Ideal for Novice Investors

Copy trading is particularly attractive to novice traders. We’re talking about complete beginners without any prior trading experience. Rather than ‘guess’ which way the markets will move, beginners can leave all of the groundwork to their chosen trader. 

This is because the trader will research the markets based on their own strategies. This could be a technical and/or fundamental strategy, or perhaps a combination of the two. Either way, no input is required from the investor; the trader does it all. 

This is also the case when executing orders. The trader being copied will determine the most effective entry price. They’ll also evaluate which stop-loss and take-profit levels to deploy. Ultimately, copy trading can help you avoid the same mistakes made by most novices.  

Save Time

Copy trading saves investors a significant amount of time. Let’s use an experienced forex day trader as a prime example. The trader will likely spend several hours each day analyzing their pricing charts. 

This means deploying technical indicators and drawing tools across multiple time frames. The trader will also explore the fundamentals to ensure there are no false readings. They’ll then need to think about the most suitable entry and exit prices, in terms of risk and reward.

All of this requires considerable time each day. Fortunately, this goes on behind the scenes. You’re simply investing in the copy trader, meaning you’ll replicate their success or losses. This frees up time to focus on other daily tasks.  

Actively Trade While Remaining Passive

Most passive income streams are slow and steady. For example, investing in real estate will get you monthly rental payments. Similarly, investing in a mutual fund will get you quarterly dividend distributions. 

While predictable, neither of these methods allows you to actively trade the financial markets. This means you’re potentially missing out on trading opportunities. For example, day traders are in the market every day. While they target small gains, they’ve constantly got skin in the game. 

Therefore, copy trading allows you to actively trade the markets while remaining passive. Whether you’re looking to trade gold, oil, major forex pairs, Bitcoin, or the S&P 500, copy trading ensures you’re always in the market. 

Risk Management Tools

Most copy trading platforms allow you to adjust the risk management settings. This should supersede the risk management orders deployed by the trader you’re copying. For example, you can usually choose your own stop-loss percentage. 

Suppose you never want to lose more than 1.5% on a single trade. Let’s say the copy trader has deployed a stop-loss order at 2%. Even so, your position will automatically be closed if it declines by 1.5%. 

Copy trading tools often allow you to set caps on each position too. For example, you might not want to risk more than 5% of your account balance per position. Even if the trader risks more than this, it won’t be reflected in your account.  

However, you should be careful about overriding the risk management tools set by the trader. Their stated risk levels might be aligned with a specific strategy. This means you might be exiting an order too early.  

Drawbacks of Copy Trading

Copy trading also comes with several drawbacks. These should be considered before proceeding. 

Loses Will Also Be Replicated

Copy trading allows you to replicate another trader like-for-like. This includes winning and losing trades. Put otherwise, your portfolio will mirror the trade you’re copying. So, if they go on a prolonged losing run, so will you. 

Crucially, there’s no guarantee that you’ll make money when copy trading. On the contrary, you could make a financial loss. A great risk management strategy is to create a diversified portfolio of copy traders. This will ensure you’re not overly reliant on just one individual.

Human Traders Suffer From Emotions 

You should remember that human traders suffer from emotions. This can often lead to irrational trading. For example, the trader you’re copying might begin increasing their stakes to cover previous losses. This is a recipe for disaster. 

As we’ve established, any losses made by the trader will be replicated in your own account. In contrast, Algobot – our algorithmic trading bot, doesn’t suffer from emotions. It deploys a systematic strategy based on technical indicators, artificial intelligence, and machine learning. 

Limited Markets and Trading Hours 

Copy trading also comes with various limitations. For a start, you’ll be limited in what markets you can trade. For example, if you’re copying a seasoned forex trader, they likely don’t have any experience in crypto assets. As a passive investor, this means you’re missing out. 

The only workaround is to copy multiple copy traders. However, as we cover shortly, copy trading providers often set high minimums. Another limitation is that copy traders can only trade for a certain number of hours each day. 

Trading too much will result in fatigue, which leads to errors. Once again, Algobot functions on a predefined algorithm. This means it can analyze multiple markets simultaneously, 24 hours per day, 7 days per week. All without trading emotions or fatigue.  

Copy Trading Platforms Overview

In this section, we’ll explore some of the best options when choosing a copy trading platform. 

1: eToro – Regulated Broker and the Most Popular Copy Trading Platform

eToro is considered the de-facto copy trading platform. Launched in 2007, eToro has over 30 million registered users. It offers a safe and user-friendly trading experience. eToro is regulated by several financial bodies, including ASIC and the FCA. What’s more, the minimum first-time deposit starts from $10.  That said, account minimums can increase depending on where you’re based.

eToro is both an online broker and a copy trading platform. This means you don’t need to connect eToro with a third-party provider. Simply choose a trader to copy, type in your investment amount, and confirm. There are thousands of copy traders to choose from on eToro. It offers a simple interface alongside real-time data. This makes it easy to find suitable traders to copy.

For example, you can focus on the historical return on investment, preferred asset class, or the average trade duration. Click on a trader to view more statistics, including the maximum weekly and monthly drawdown, risk rating, and assets under management. There are two main drawbacks to consider when using eToro. First, the minimum copy trading investment is $200 per trader.

This might be too much for some investors. Second, some eToro markets come with high fees. For instance, you’ll pay a 1% commission when trading crypto. Similarly, spreads on EUR/USD start at 1 pip. That said, stocks and ETFs can be traded at 0% commission. We also like that eToro offers a demo account. This includes support for copy trading, meaning you can figure things out without risking any money. 

2: NAGA – User-Friendly Copy Trading Platform Supporting Over 1,000 Markets 

NAGA is another popular copy trading platform that’s aimed at beginners. It doubles up as an online broker, so no third-party integration is required. This means you can register, make a deposit, and begin copy trading straightaway. The bad news is that NAGA has a minimum deposit requirement of $250. This might be too high for budget-conscious investors.

Nonetheless, we like that NAGA accepts a wide range of convenient payment types. This includes debit/credit cards from Visa, MasterCard, Maestro, Diners, and Discover. It also supports bank wires, although this will delay the deposit process by several days. All payment methods are fee-free, unlike eToro. In terms of supported assets, NAGA lists more than 1,000 financial markets.

All are backed by contracts-for-differences (CFDs), meaning that leverage is available. Markets include major, minor, and exotic forex pairs, stocks, indices, commodities, ETFs, and futures. Crypto assets are also supported, including Bitcoin, Decentraland, Ethereum, and Cardano. Another drawback with NAGA is that copy trading fees are considered high.

For instance, every position your copy trader enters will cost you €0.99. This can quickly add up if you’re copying an intraday trader. In addition, if your trader makes more than €10 on a single trade, you’ll pay a 5% commission. All that said, NAGA offers a safe and regulated trading experience. Its parent company is listed on the Frankfurt Stock Exchange. It also holds several brokerage licenses. This includes CySEC and the FSA. 

3: MT4 – Third-Party Trading Platform That Connects to Hundreds of Brokers  

The next option is MetaTrader 4 (MT4), which is one of the most popular third-party trading platforms in the market. It sits between traders and online brokers, providing high-level charting tools, technical indicators, and custom order types. While MT4 doesn’t directly offer copy trading, its marketplace gives you access to thousands of signal providers. 

For all intents and purposes, this is exactly the same as copy trading. This is because you’ll be copying another trader that uses MT4. In terms of markets, MT4 covers every asset class imaginable. This includes forex, crypto, indices, stocks, and commodities like gold and silver. Before getting started, you’ll need to download the MT4 software to your desktop device. 

Next, you’ll need to open an account with an online broker that supports MT4. There are hundreds to choose from, including many 0% commission platforms. After that, you can browse the MT4 marketplace to find a suitable trader to copy. You can search for the asset class, historical performance, risk setting, and other important metrics.

Most copy traders on MT4 charge a monthly subscription. We found that to average $20 – $50. We like that you can cancel at any time, so you’re never locked into a long-term subscription. Moreover, you can start off in demo mode. This allows you to test a copy trader before risking any money. In addition to copy trading, MT4 also supports automated bots like Algobot.

How to Select a Copy Trader

The most important stage of copy trading is selecting the right trader. This can be difficult, considering some platforms offer thousands of different options. 

This section will help you choose the best copy trader for your financial goals and risk tolerance.

Asset Class

A good starting point is to shortlist traders by their preferred asset class. For example, you might want to trade major forex pairs like GBP/USD and EUR/USD. Or, you might want to trade indices like the S&P 500 and Dow Jones.

Either way, focus on traders that specialize in a specific market. Conversely, avoid traders that offer exposure to too many assets. For example, if a trader has recently bought and sold cryptocurrencies, forex, commodities, and indices – this likely means they’re a Jack of all trades and a master of none. 

Past Performance 

It’s also good to shortlist traders by their historical performance. The good news is that when using established platforms like eToro, NAGA, and MT4 – past performance figures cannot be doctored. This means you can be sure they’re credible and legitimate. 

• Now, it can be tempting to focus exclusively on traders with the highest returns to date.
• However, you should also consider what period the results cover.
• For example, suppose the trader has made over 1,000% since joining the respective platform. If this is based on just a few months of trading, then the results are likely skewed.
• It’s also likely that the trader used high-risk strategies, such as leverage.

In contrast, now consider a copy trader that has made historical returns of 170%. If this is based on four years of trading, this is a very good sign. That said, you’ll also need to check the month-by-month data. This ensures that the trader is making consistent profits. This will give you the best chance possible of outperforming the market in the long run.

You also need to consider how much you personally want to make from copy trading. This needs to be more than the market average. For example, suppose your chosen trader specializes in the S&P 500. Considering the S&P 500 averages growth of 10% per year, you’d want to be making a lot more than this. Otherwise, you could just invest in the S&P 500 via an ETF.

Risk

Risk should also be considered when choosing a trader to copy. There are several ways that you can assess risk. Some copy trading platforms automatically assign a risk rating to their traders. This is based on various metrics, such as the maximum drawdown and the underlying strategy. However, it’s best to perform your own risk assessment. 

First, consider which types of financial instruments the trader typically trades. For instance, consider a forex trader. A risk-averse forex trader will likely focus on major pairs like EUR/USD. Not only is EUR/USD the least volatile pair but it’s also the most liquid. In contrast, a high-risk forex trader might focus on exotic currencies like the Mexican peso or the Thai baht. Exotic currencies can be ultra-volatile, making them a high-risk market.

Maximum Drawdown

The maximum drawdown also forms a part of the risk management assessment. This will help you choose a trader that aligns with your goals and risk appetite. Crucially, most copy trading platforms show you the maximum monthly drawdown, which is a key metric to be aware of. 

So how does the maximum drawdown work? In simple terms, it shows the maximum historical decline of a trader’s bankroll from a previous peak.

For instance:

• Let’s suppose that the copy trader started with a bankroll of $10,000.
• After a few months, they’ve increased the bankroll to $15,000.
• After an extended losing run, the trader’s balance is now $12,000.
• This amounts to a drawdown of 20% from the previous peak ($15,000).

So, when you’re reviewing copy traders, the drawdown informs you of how much risk they generally take. For example, if the maximum drawdown is just 5%, this means you’re copying a risk-averse trader. But if the drawdown is more than 20%, they’re likely adopting a high-risk strategy.

Drawdown percentages have a lot more validity when they’re based over longer periods. This is much the same as past performance metrics.

Assets Under Management / Followers

It’s also worth considering how popular the copy trader is with other investors. Although not an exact science, it’s a good sign if the trader has substantial amounts invested in them. Similarly, if the trader has a considerable number of followers, this could be a bullish signal. 

Engagement With Investors 

Another metric we like is engagement. Put otherwise, how much time does the trader spend communicating with their investors, if at all?

For example, some copy traders hold monthly webinars. This updates investors on broader market conditions and the current strategies being deployed. This also enables investors to ask questions directly to the trader. 

 

Strategies for Successful Copy Trading

Here are some strategies that can help you become a successful copy trader:

• Independent Research: Before getting started, make sure you conduct plenty of independent research on a trader. It’s crucial to know everything there is about the trader, such as their preferred strategy, target market, and overall risk tolerance. You don’t want to discover any surprises after you’ve invested money.
• Understand Fees: Beginners often forget to incorporate fees into their return on investment. Make sure you have a firm grasp of all related fees. This should include deposits and withdrawals, trading commissions, and spreads. You’ll also need to factor in the trader’s commission. This is usually a percentage of any profits they make.
• Diversification is Crucial: Never put all of your eggs into one basket. This means you should spread your copy trading investments out across multiple traders. For example, if the minimum copy value is $100 and you’ve got $1,000 to invest, copy 10 different traders. If one trader doesn’t perform well, only a small percentage of your overall portfolio will be impacted.
• Ongoing Monitoring: Although copy trading is a passive investing tool, you’ll still need to keep tabs on how your investments are performing. This means checking in with your copy traders at least once per month. Assess their performance against the broader markets and that they’re sticking to the proposed strategy.
• Start With a Demo Account: If you’re completely new to copy trading, we’d suggest starting off with a demo account. Many platforms offer demo facilities; you’ll be copying traders but with virtual funds. This will give you a clear idea of whether copy trading is the right investment tool for you. If it isn’t, at least you haven’t risked any funds.

The Verdict

We’ve covered everything there is to know about copy trading. Although copy trading offers a passive investing experience, automated bots excel in most departments.

In particular, Algbot trades 24/7 across multiple asset classes, including forex, crypto, and stocks. Simply connect Algobot with a third-party platform to start trading autonomously today.  

FAQs

What is copy trading?

Copy trading is an investment tool aimed at beginners. It enables investors to ‘copy’ an experienced trader like-for-like.

Is copy trading legal?

Yes, copy trading is legal. As long as online trading is allowed in your home country, you can legally copy other traders.

How profitable is copy trading?

Copy trading can be profitable, but it depends on the performance of your chosen trader. If the trader makes 10% gains, you’ll also make 10%. Naturally, if the trader loses money, so will you.

Can you lose in copy trading?

Yes, if you’re copying a trader that makes a loss, these losses will be replicated in your own account. Therefore, consider the risks before proceeding.