The Dangers of Copy Trading

What you should know about ‘copy trading’

You’ve probably seen adverts on YouTube and elsewhere about copy trading. The adverts are designed to fill inexperienced investors, with confidence about how easy it is to make money on the stock market.

Two of the biggest deterrents of investing in the stock market are fear of loss and lack of market knowledge. Copy-trading aims to address both of these fears and make investing seem straight forward and stress-free.

This blog seeks to explore the idea of copy trading by asking what it is, how are ‘promoted traders’ chosen, and if ‘copy trading’ is a sensible investment strategy.

What is Copy Trading?

‘Copy trading’ is a method which allows market traders (which can be anyone with a trading account) to automatically copy the positions of a selected investor.

This is normally available in social trading networks. A number of trading platforms offer copy trading.

As an example, if you have an investor who places $5,000 onto a trading platform, they may not feel confident in making trading decisions themselves due to lack of market knowledge or lack of time to monitor investments. This investor can choose to copy the trades of a promoted trader on the site.

Their portfolio will be invested in the exact same way as the promoted trader. So whenever the promoted trader makes a trade, the investor does too.

 

Read More: The Dangers of DIY Investing in a Financial Crisis

How are promoted traders chosen?

Different social trading platforms have different methods of choosing their ‘promoted traders’, however, some of the metrics which are used on the more popular sites include investor profitability and total gain.

n.b. the majority of social trading sites make no mention of their promoted traders holding any financial qualifications.

Is copy trading a sensible investment strategy?

On the surface, it seems a very attractive proposition. Invest your money and let a successful investor make decisions for you without paying an extra fee.

But how much success have users experienced?

A poll run by the website, Social Trading Guru found that 67% of respondents said ‘they already lost money with social or copy trading’. Social Trading Guru published 5 reasons why most people lose money with copy or social trading. We’ve explored 4 of the reasons in this blog.

Unrealistic expectations 

Adverts for copy trading platforms often highlight the huge potential for gains by simply copying an investor with a successful track record.

When people see these exceptional results, they set their expectations accordingly. What many people fail to account for, is market timing. Promoted traders with the best figures may well have just reached a peak in their portfolio. By copying their trades, you may have missed the best days in the market.

Copy traders may also be unaware, that traders who have earned the top returns may be investing in extremely volatile stocks, which could soon drop sharply in value.

Lack of diversification

Many trading platforms offer just equities. Most financial advisers would assist clients in building a portfolio with exposure to different asset classes to protect the client. By just using a copy trading platform, investors will often be overexposed to equity market downturns.

Emotional investing 

Inexperienced investors often chase returns and crystallise losses. If you copy a trader based purely on gains, you may be inclined to pull out or sell when the markets drop. Unlike receiving advice from an adviser who will hold your hand through different parts of the market cycle, if you make decisions on your own, you may make crucial mistakes by buying high and selling low.

Lack of patience

Investors are often sold on the idea of copy trading due to the lure of high returns. Beware. Markets have good years, bad years and flat years. The key is often, ‘time in the market, not timing the market’ says Tom Elliot deVere’s Senior Investment Strategist and former Executive Director at JP Morgan Asset Management. If you pull out due to lack of activity, again, you are risking missing the best days in the market.

The majority of copy trading platforms use CFD accounts whereby traders and investors have the opportunity to profit from the price movement of stocks or commodities without owning the underlying asset.

Let’s take a look at the figures of popular trading sites according to a report from Finder.com.

80.5% of CFD accounts lose money

76% of CFD accounts lose money

75% of CFD accounts lose money

72% of CFD accounts lose money

Conclusion

Copy-trading can often seem an attractive proposition. Investors can often be led to believe that by simply copying a successful investor, you will become a successful investor yourself. Unfortunately, the statistics don’t back the advertising up. There are a multitude of reasons why investors receive poor results as commented on above, including lack of understanding of risk, lack of patience, poor market timing and emotional investing.

 

deVere believe in the importance of retail investors seeking financial advice from professional, qualified and regulated financial advisers. deVere’s advisers help build clients a portfolio in line with their long-term goals and their capacity and appetite for risk. When it comes to your money, ensure you receive quality advice which is bespoke for your needs. To request a no-obligation consultation, please click on the link below.

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deVere Insights is a proud component of the deVere Group. Our company has always prided itself on leading the way in the sphere of wealth management. This website is in place to share information and expertise.