The Ultimate Guide to Copy Trading (2022)

MORITZ PUTZHAMMER

02 February 20229 min read

Table of contents

It is often said that imitation is the highest form of flattery, but it can also be extremely profitable. If you want to trade like the best, then a case can be made for emulating the best traders, but with an eye to tweaking your strategy according to your own individual needs and circumstances.

As its name implies, copy trading involves a community of traders, rather than one single trader, and it is precisely this social experience that has attracted the attention of companies across a range of industries, who are now catering to our more communal instincts.

It’s actually part of a larger phenomenon referred to as social trading in which a retail investor can manage wealth by directly following the financial advice of other traders. The process typically involves the sharing of opinions on markets via dedicated social media platforms in which traders can make friends, post opinions, and communicate with other investors, all of which can then be used to make trading decisions. One surprising recent example involves newbies trading investment tips on TikTok.

Often referred to as Social+ companies (e.g TikTok, Fortnite, or Minecraft), these companies focus on a specific category (e.g., fitness, finance, food, etc.) and integrate an authentic and unique community around a product within that category. A perfect example is Trality’s Marketplace, where bot creators and bot followers can meet and collaborate for mutually beneficial ends.

What is copy trading?

So what is copy trading? At first glance, it seems fairly straightforward: copying the trading of someone or something else. But there’s actually more to it. The more you read about it, the more you’ll realize that copy trading sounds remarkably similar to practices such as social trading and mirror trading. In fact, it can be quite difficult for newer traders to disentangle the distinctions between copy trading, social trading, and mirror trading, which is why it’s so important to define our terms.

Quite simply, copy trading involves copying trades made by one specific trader. On the other hand, mirror trading is when a trader uses algorithms to determine the best general strategy based on the actions of a group of traders. And moving from specific to general, social trading involves observing the trading behavior of other traders (expert or otherwise) and following their strategies using either copy trading or mirror trading.

If it sounds like variations on a theme, then you’re not far off the mark. Let’s think about how these practices developed, which should clarify things. Investopedia defines copy trading in the following way:

“Mirror trading is a methodology of trade selection. It is a strategy that allows investors to copy the trades of experienced and successful forex investors and implement the same trades, in almost real time, in their own accounts. Mirror trading was initially only available to institutional clients but has since been made available to retail investors through various means. Since its inception in the mid- to late-2000s, mirror trading has inspired other similar strategies, such as copy trading and social trading.”

As you can see, the terms are used interchangeably (“copy” and “mirror”) even by a highly trusted source, which can be confusing when trying to differentiate between copy trading software, copy trading strategies, mirror trading, and even social trader tools. What the above quote (and article) is actually describing is copy trading. Let’s take a look at another definition – this one from Wikipedia:

“Mirror trading is sometimes also referred to as copy trading although copy trading differs slightly from mirror trading in the way that accounts are linked. In copy trading, the trader directly copies the moves of an individual successful trader; whereas in mirror trading, investment decisions are based on algorithms developed from trading patterns of a number of successful traders.”

copy trading, social trading

An even clearer definition by a number of academics in a research paper describes copy trading in the following way:

“This feature enables investors to replicate – in real-time and in their own accounts – the actual trades of other investors. An investor is allowed to follow other traders for a fee and have the platform automatically execute the trades of other traders on her own account in a real time manner.”

The above-mentioned examples offer clear and concise explanations with easy-to-understand definitions, while also paying attention to the finer distinctions between copy trading and mirror trading. And finally, there is social trading. It’s best to think of it as a general practice of observing the trading habits or patterns of one’s peers or larger institutional investors and then following those strategies by using either copy trading or mirror trading.

What are the advantages of copy trading?

As with everything in life, there are advantages and disadvantages to using copy trading, ones that you should always keep in mind when choosing a trading strategy (or strategies) and whether to copy pro traders. These include 1) greater transparency since every single trade is observable, 2 ) far greater control over trade executions by individual traders, 3) lower fees, and 4) lack of exposure to unscrupulous financial advisors and financial advising services, which can often have hidden agendas. With copy trading, conversely, what you see is what you get.

Transparency

Since investors will have access to every single trade of a trader, there is greater transparency. In fact, greater information transparency has been fueling the ongoing disruptive innovations within the FinTech space, as everyday traders continue to migrate away from traditional fund management and brokerage services due in part to a fundamental lack of transparency. When it comes to many social trading platforms, for example, all trades by each trader are often publicized, and it is this commitment to information transparency that is behind the explosive number of users who are copy trading crypto (for example).

Simplicity

You’re not a professional trader. You don’t have years of trading experience behind you. And you definitely don’t know the ins and outs of global markets and market principles. For these reasons and others, copy trading can be an excellent way for the curious newcomer to become acquainted with trading and acquire a more sophisticated understanding of trading strategies. Think of it as an apprentice of sorts (but with minimum risk), as you follow successful traders with robust portfolios. Beware, however, of those who do not charge anything. Knowledge is power, but it certainly isn’t free.

Efficiency

Continuing with the apprenticeship metaphor, you’re probably like most people – simply looking to get a leg up in the investment game. Trading isn’t your life, but you wouldn’t mind supplementing your strategy with some tried-and-tested, real-world help. Instead of spending countless days and months (and even years!) of trial and error, scouring websites and books for an optimized trading strategy with profitable returns, you can opt instead to copy someone who has already done all of the work for you. In many cases, it might be far better to pay a copy trading pro and let them do the heavy lifting for you. The process of copy trading itself can also be automated, saving you even more time.

Data-driven

Another benefit of copy trading is that you have access to a full range of statistics and metrics – or should under ideal circumstances. Within social trading, however, there is something called the “transparency-revenue conundrum.” Trading platforms have to work out a delicate balance when it comes to transparency. In the first instance, they have to release traders’ trading information as quickly and transparently as possible in order to equip followers with the requisite data to make an informed decision as to whether to follow a particular trader.

However, too much transparency may lead to losses for the platform, as followers may be able to employ certain techniques to avoid paying following fees. Thus, there is a need for information transparency, i.e., detailed versus aggregate trading performance and the timed release of data, i.e., immediately or with a delay. Since speed is crucial, especially in a fast-paced trading market such as crypto, copy trading platforms tend to release as much data, including aggregated metrics and specific trade-level info, as quickly as possible.

Flexibility

Right, so you’ve done your research. You checked the data. You’ve decided to copy the moves of an individual successful trader. There’s only one problem: the individual successful trader isn’t exactly turning out to be, well, successful. What can you do with the strategy that you’re copying? Drop it and move on quickly. With copy trading, you’re always in control. Simply walk away whenever you decide that copying someone no longer makes sense financially. One of the beautiful aspects of copy trading is that traders are incentivized to be successful, otherwise few people would continue to copy them – one hand washes the other.

What are the disadvantages of copy trading?

It should be clear by now that copy trading has obvious advantages and can often be one of the best solutions for many traders, but there are some possible downsides of which you should be aware.

Incongruous goals

What’s to say that your goals align with the goals of the trader that you are following (or might follow)? Having fundamentally different trading aims and purposes can often mean that your strategy as a follower can be out of sync with the strategies of the traders that you decide to follow, which can obviously have negative short- and long-term consequences.

Nobody’s perfect

Sure, success is a wonderful thing, especially when you’re piggybacking off of someone who has done the dirty work for you. But with the good comes the bad. What happens when the trader that you’re following encounters a flash crash, a sideways market, or even a bear market? That trader’s losses will become your losses, and you’ll be faced with the uncomfortable decision of either continuing to follow the trader as you both ride out the troubled waters of crypto markets or simply abandon ship and search for more profitable traders to follow.

Commissions

While some of the best things in life are free, quite a number of the best things when it comes to trading and investing are not. Professional copy traders will require a commission payment for their services – and why shouldn’t they! Depending on your level of investment, though, these commission fees can quickly eat away at your bottom line, turning profits into losses if you’re not careful.

Black hat techniques

While trading platforms have increasingly erred on the side of almost complete information transparency when it comes to a trader’s trades, how much do you really know about that trader? Can or should you trust them with your hard-earned cash or coin? And how can you tell if their follower numbers are legitimate or simply inflated through nefarious black hat techniques? The age-old adage applies: caveat emptor or buyer beware.

Unrealistic expectations

There is a psychological tendency to think that novel approaches to investing are shortcuts to wealth. They’re not. One of the greatest difficulties that every single investor will face, whether they’re involved in crypto or any other type of investment or asset class, is setting realistic expectations. FOMO and FUD: there’s a reason why you’ll often encounter the same acronyms over and over again. Fear of missing out as well as fear, uncertainty, and doubt are just human nature.

Is copy trading really profitable?

The short answer? It absolutely can be. After all, social trading has continued to surge in popularity and with good reason. If people weren’t making money from it, then people wouldn’t continue to do it. It really is that simple.

But there are things that you should bear in mind when considering copy trading and profitability. Just as businesses must know their customers, so too should you do your due diligence when picking a reputable trading platform. Copy trading should only be done through a trusted source.

Regulatory concerns are also something to keep in mind. Most social trading platforms, including the ones that offer copy trading, are regulated. For example, in 2015 the Financial Conduct Authority (FCA) ruled that all traders in social trading need to comply with the MiFID II ruling to qualify as investment managers. And with the U.S. regulatory environment constantly changing, copy traders who are residents of the United States or those using U.S.-based copy trading platforms need to stay abreast of ongoing regulatory developments in order to ensure full legal compliance.

Is copy trading good for beginners?

Copy trading provides an excellent entry point into the world of crypto trading.

Since beginners are naturally in the early stages of their trading careers, copy trading allows them to learn from the best, copying successful, profitable traders and their strategies with a minimum amount of time, energy, and resources that would have otherwise been needed had the beginner started from scratch.

Additionally, instead of having to master two separate and increasingly complex subject areas – in this case copy trading and cryptocurrencies – those new to crypto and copy trading can gain exposure to both while learning the ropes. And they can do so while minimizing their risk and increasing their knowledge throughout the process.

Conclusion

So now you know: copy trading can be an extremely effective and profitable way to trade, especially for newbies.

Remembering a few key points will go a long way, though. When selecting a copy trading platform, check the spreads and transaction fees, which can often come as an unpleasant surprise for unsuspecting beginners.

Choose a good trader with a solid and transparent track record of success over an extended period of time. Anyone can get lucky. Your aim is to identify a pro copy trader by their long-term successes.

Manage your expectations and control your emotions. Temporary losses can and will happen, but you shouldn’t decide to no longer follow a trader prematurely because of fear, doubt, or uncertainty. Similarly, when copy trading crypto, take advantage of the power, consistency, and reliability of crypto trading bots.

And always remember the golden rule of investing: never risk more than you can afford to lose!