There are two major ways to participate in the financial markets – you participate either as a trader or as an investor. An investor buys an asset in the hopes that the value of the asset will rise enough to turn a profit sometime in the future. For folks who have a short-term focus, trading might be a smarter and faster way to make money than traditional buy-and-hold investing. A trader gets to profit from the fluctuations in the prices of the assets in his/her portfolio multiple times within each trading session.
The problem, however, is that you can’t just wake up and become a trader overnight. Becoming a trader requires hundreds of hours spent learning how the market works, what moves the markets, how different assets respond to different market stimuli, and how other market participants react to different kinds on market news.
Pros of copy trading
The first benefit of copy trading is that it helps you to shorten the learning curve to becoming a market participant. Many potential traders spend a great deal of time learning how to trade, such that they never feel ready enough to take the plunge and start trading. Once you understand basic market terminologies, you can start trading with the confidence that you have a seasoned trader holding your hands through the market.
The second benefit of copy trading is that it increases your odds of making profits while reducing your chances of recording losses. As much as 90% of new traders lose money when they get started in the market, 40% of new traders quit within a month, and as much as 83% of new traders quit within 3 years. Copy trading helps you to mimic the actions of the experts and reduce your odds of incurring losses.
The third reason copy trading is a smart strategy for getting access to Wall Street is that it allows you to earn even as you learn about the markets. Constant practice with real money (as opposed to a demo account) will help you become adept at understanding the market than any form of reading that you can embark on. With copy trading, you get to gain practical knowledge, but you also earn money in the process.
Cons of copy trading
Despite the pros of copy trading, many traders often fail to conduct due diligence before rushing into the market. You need to have a basic understanding of the market, know how to rate the performance of other traders, and get an inkling of when the trade you are about to copy makes sense or otherwise.
Secondly, copy trading could potentially encourage “herd mentality” in which people make trading decisions solely because others are making similar decisions. In the words of famed investor Warren Buffet, the successful investors must know how to be contrarian enough to “be greedy when others are fearful, and be fearful when others are greedy.”
Valuable tips on copy trading
The benefits of copy trading far outweigh the disadvantages and you’ll be doing yourself a great disserve if you don’t take advantage of the shorter learning curve that copy trading offers. However, to get the best out of your copy trading activities, the following tips can stand you in good stead.
- Diversification is important in all forms of trading and investments, you should consider spreading out your risk by copy trading multiple traders. Unless the market is down, it is highly unlikely that all the traders you are copying will have a losing streak all at the same time.
- Copy trading is a passive way to be involved in the market, but it’s not in your best interest to set all your trades on autopilot. You should take the time to monitor your trades – if you unwittingly copy a bad trade, don’t hesitate to end that trade and cut your losses.
- Take the time to find reliable traders to copy. All traders will have several winning and losing trades, the key to profitable trading is to have more winning trades than losing trades. When searching for traders to copy, look for people with a long list of winning trades, traders who make frequent trades, and traders who don’t make rash trading decisions.
