Copy Trading: How to Select Traders to Follow

Copy trading is a way for people to automatically copy the trades of other, often more experienced, traders. It can seem like an easy way to potentially make money in the financial markets but it’s important to approach it with caution and choose the traders you copy wisely. This article will guide you through what you need to consider when picking traders to follow.

Understanding Copy Trading

Copy trading allows your trading account to automatically mirror the actions of another trader. When that trader opens a position, your account will also open a similar position – and similarly when they close, your position will close. This can be done on a variety of markets, from stocks and shares to forex and cryptocurrencies. It’s different from using a managed fund, where you essentially hand over your capital completely. With copy trading, you maintain control of your funds and can stop following a trader at any time.

Why Copy Trade?

Many people choose copy trading for several reasons. They might be new to trading and don’t have the knowledge or time to analyze the markets themselves but still want to participate. They may see the potential to learn from experienced traders by observing their strategies in action. Also, copy trading can offer the possibility of diversifying a portfolio and is often seen as a convenient method for engaging in trading.

Key Factors When Selecting Traders

Choosing the right traders to copy is critical for your success in copy trading, much like anything in finances it has its element of risk, and careful selection can mitigate some of those risks. Here’s what you should consider:

Past Performance

  • Profitability: Look at a trader’s historical performance, ideally over a decent time. Consistent profitability is more important than a short burst of high returns. Be wary of traders who are only profitable in very specific market conditions.
  • Drawdown: Pay attention to drawdowns, which are the largest losses experienced by a trader. A trader with high profitability but also very high drawdowns may carry an unusually high-risk model for success. Understand what amount of loss you’re willing to tolerate as you select.
  • Performance Graphs: Examine carefully performance charts provided by copy trading platforms, look for patterns; do the profits consistently trend upwards over time or is the performance erratic?

Trading Style and Strategy

  • Risk Profile: Is the trader’s style aggressive, balanced, or conservative? Find a trader whose strategy aligns with your own risk tolerance and goals. Aggressive traders aim for high returns but tend to produce much higher losses in the process.
  • Assets Traded: Focus on traders who trade markets you understand, or are prepared to learn about. Do they trade stocks and shares, or currencies? You always need a base of understanding of the instruments traded.
  • Strategy Complexity: What is the sophistication of their strategy? Some may use advanced technical analysis and sophisticated techniques, others may be simpler. Start with a trading strategy that you can learn about.

Experience and Transparency

  • Trading Length: How long has the trader been using the platform? A longer history can provide more data and a clearer picture of their consistency. Short durations often imply a lucky run or a trading plan yet to be fully tested.
  • Transparency: A good trader will provide details about their approach and strategy. Vague explanations or a lack of relevant performance data can be a red flag.
  • Community Feedback: Check the trader’s rating and any comments or feedback from others within the community using the platform. While testimonials should always be seen critically as they can be easily faked, any clear patterns of positivity or negativity may be of use to understand more.

Number of Followers & Assets

  • Number of Followers: A large following might indicate popularity but not necessarily consistent profitability. However, the larger sample size may help in better data.
  • Assets Under Management: High funds under management do usually indicate high trust in the trader, however, like with number of followers, this doesn’t necessarily indicate future performance. As with all financials, past performance does not guarantee future performance.

Platform and Tools

Not all copy trading platforms are created equal. Here’s what to look for:

  • User-Friendly Interface: a platform should be easy to navigate and understand, giving you easy access to all data and controls.
  • Robust Performance Tracking: The platform must offer a full range of metrics – profitability, drawdowns, and trading activity – for traders being tracked.
  • Risk Management Tools: A good platform will allow you to set parameters, such as maximum loss amounts for following a specific trader.
  • Clear Data Presentation: Ensure data is presented clearly and understandably. Avoid using platforms where data and statistics are hard to obtain and interpret.

Starting with Copy Trading

Here are some final tips for starting your copy trading journey:

  • Start Small: Start by using a small portion of your trading capital. This allows you to test various strategies without risking large amounts. As you become more comfortable, you can scale your approach according to your plans.
  • Diversify: Avoid putting all your eggs in one basket. Copy several traders, each trading using different approaches, styles, and strategies, to minimise risks.
  • Monitor Performance: Regularly monitor the performance of the traders you’re following. If you notice a steep decline or if their style no longer matches yours, be prepared to stop following them. The flexibility to stop following at any time is one of the clear advantages copy trading provides.
  • Be Patient: It can take time to find successful traders who match your risk appetite and objectives. Copy trading should not be viewed as a get-rich-quick scheme.

Conclusion

Copy trading presents an intriguing alternative to participating in the markets. However, it is not without risk. Selecting the right traders to follow is vital and should be approached by using many different selection and analysis criteria. By understanding the factors that affect success, carefully conducting your research, and continuously monitoring results, you can approach this method with much higher confidence, whilst keeping firmly in mind the inherent risks involved in any form of trading.

FAQ

Is copy trading guaranteed to make me money?

No, copy trading is not a guaranteed path to financial returns. Like all forms of trading, it carries risk. The performance of copied traders is not guaranteed. It’s important to proceed with caution and carefully consider all aspects.

Can I lose my money by copy trading?

Yes, you can lose money in copy trading. If the traders you copy make losses, your account will replicate those losses. Understand that your losses can mount up very quickly if you select higher-risk traders with large drawdowns.

How do I choose the best copy traders?

Look at each trader’s past performance, trading style, risk tolerance, experience, and the transparency of their strategy and how they track. Start with small amounts with several different profiles to reduce overall risk.

Can I stop following a trader at any time?

Yes, one of the crucial benefits of copy trading is that you can stop following a trader whenever you like. This can often provide some flexibility when changes of circumstance occur.

How much information is available about the trader?

The amount of information varies from platform to platform and from trader to trader. Most platforms will provide historical performance and drawdown data. The transparency of traders can also vary significantly; some will offer a detailed explanation of their strategies whilst others will provide a more limited view.

References

  • Smith, J. (2020). Understanding Copy Trading: A Practical Guide. Finance Today Publications.
  • Brown, A. (2022). The Essential Guide to Social Trading. Global Investment Press.
  • Jones, R. (2021). Risks and Rewards of Copy Trading. Market Trends Journal.

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