Copy trading is a relatively new phenomenon in our trading world and as a consequence it’s still very much misunderstood and often maligned. The procedure and process is very straightforward; many brokers, who offer copy trading services, have a leader board of client-traders who have decided to share their trading history, for a small fee per trade off each trader, who then decide to follow them by placing identical trades. The more successful the trader is on the leader board then (in theory) the more followers they’ll have and the more success they’ll enjoy in terms of their commissions per followed trades they make.
The temptation to abandon the trading methods and skills we’ve spent perhaps years developing, in favour of simply following somebody on the leader board, can be very intense. After all, these leaders on the board must be there for a reason and it can’t be failure. However, on the leader board there could be traders who have enjoyed a massive short term boost by using excessive risk. For example, if a new trader to the copy service risked 30% of a very small account and the bet paid off twice in series this could have a massive effect on their relatively short term trading history. In short they could rapidly ascend the leader board and appear very attractive to new, inexperienced traders looking for a leader to follow. The onus is therefore on us to analyse the leaders on any copying service we might be considering interacting with.
To separate the good, the bad and the very ugly in our copy trading option requires a little bit of analytical skill and in many ways it’s fairly obvious exercise to find what we should be looking for in four easy steps.
* Firstly we should be ideally looking for a trader on the board who has a history of a year or more.
* Secondly, we should be looking for a trader who doesn’t take excessive risk.
* Thirdly, we should be looking for a trader who makes reasonable returns, not extraordinary.
* Fourthly, we should be looking for a trader who has kept their drawdown to a sensible level.
There are other criteria but these four should be our main search criteria. So our ideal leader might be someone on the board for a year as a minimum, which has possibly only experienced a 15% drawdown, which risks no more than two percent per trade and makes returns of up to 100% per annum. Does that criterion read like a familiar list? It should do as in many ways it’s the ‘perfect’ trader profile we’ve often laid bear in this very trading blog in countless articles over the years.
So, if we are a trader considering following a leader, at what stage of our trader development should we take the plunge? Should we follow the leaders at the beginning of our trader journey, when we’re at the mid stage of our experience, or when we’re fully experienced but suffering a trader low due to a variety of reasons? Or are these services relevant whatever your experience and more applicable to traders who are time poor? There is no definitive answer as all the rationale listed is credible. However, we’re going to concentrate on one aspect of this opportunity by using certain presumptions.
We’re going to presume that our trader has some experience, has developed a robust overall trading strategy, which they’ve now committed to their bullet proof trading plan, but has somehow lost their way recently and have suffered a drawdown. And after suffering a drawdown they then begin to analyse their strategy, make repairs and changes to their method, but then once again as they re-join the market they continue to lose. Therefore they decide to stop trading for a period of time whilst they attempt to fix the broken parts of what was previously a winning system. This is an ideal time to consider copy trading for a variety of reasons:
* It’ll offer a refreshing change.
* It provides an opportunity to get up close and personal with someone else’s technique.
* We get to analyse other traders’ performance.
* We get a terrific overview of the rest of the market and the direction in which the industry is headed.
Having decided on a leader off the copy trading leader board to follow, based on the criteria we suggested earlier, we still should proceed with extreme caution. The broker stats will obviously be spot on, therefore there’s absolutely no need to question the probity of the data regarding the performance, but our three Ms of: money management, mind-set and method should still take a part in our decision making.
Even if we are following someone else’s method we should still pay strict attention to the key issue of money management and control our risk down to a minimum. We should initially set a new drawdown level in single figures and dial down our risk per trade, right down to perhaps less than one percent, even as far down as 0.2% whilst we test out the leader board traders. And whilst shadowing the strategy with real money in our live accounts we should attempt to unravel their technique to see if it matches our own theories.
For example, if we’re following a swing trading strategy on a particular security we could look for the entry and exit points as we enter and close our automated trades to see if the signals overlap with any of the most commonly used indicators we refer to in our “is the trend still your friend?” weekly trend analysis column. In this way we may quickly realise that our own previous strategy was very close to that of the copy trader we wish to follow off the leader board.
Thereafter we have two main options; stay with the copy trader if it is successful, or once again trade our ‘own book’. Or the third option is to go back to trading our own book but to use a very small amount of our overall account to continue following someone from the leader board. In some ways this could be the best solution and remind us that occasionally, when it looks darkest in our trader land, the sun is about to rise.
