Opinion article by CryptoJelleNL
Trading gurus, crypto exchanges, and brokerages will try to convince you that copy trading is the holy grail – and the perfect way to achieve financial freedom without lifting a finger, calling it one of the simplest ways to take advantage of market opportunities.
At first, the idea sounds promising. You give your money to a more experienced, well-rounded trader who trades for you, and you get the profits deposited into your account. You invest little to no time, and the trader you copy does the rest.
Then, intelligent people deploy an amazing concept called common sense, and they quickly come back to the old adage that when something sounds too good to be true, it usually is.
In this article, I will dive deeper into copytrading, and why it will eventually result in you losing all of your money.
What is copytrading?
Copytrading is a tool offered by many trading platforms, that allows their users to automatically copy the trades of other traders. This feature is often heavily marketed, in an attempt to lure unsuspecting adolescents with the promise of wealth and financial freedom.
It works as simply as possible – when a trader opens a trade, the copy trading platform automatically opens trades on all the accounts that copy this trader.
For example, suppose you are copy trading "BitcoinTraderJimmy" (name has been made up for the purpose of the example). When Jimmy opens a Bitcoin along with 3% of his trading account, a proportionally-sized trade will open on your trading account as well – and the trade will only close when Jimmy decides to do so.
Platforms allow users to view performance data of the traders that can be copied, but the data often only goes back for a limited amount of time, making it very hard to properly judge the skill of the advertised traders.
Put simply, copy trading is a mechanism that allows you to automatically copy other traders, essentially letting you trade the market without investing any effort.
Can copy trading be profitable?
In essence, copy trading can be a useful endeavor for traders that are strapped for time, and want to take advantage of the market's volatility. Provided you find a consistently profitable trader, copying this trader will likely be profitable – at least in the short term.
However, over a longer period of time, problems will eventually start to arise.
Problems with copy trading
Not only is the past performance of a trader no guarantee for future results, but there are many more reasons why copy trading will lead to financial ruin in the long run.
Excessive risk and conflicts of interest
Let's slowly unravel this one. Firstly, picking the right trader to copy is incredibly hard. Because copy trading is mostly marketed towards beginner traders, they are not even aware of the qualities a trader needs to be consistently profitable. A beginner will see a trader with 50% ROI in 2 months, and unironically think they have found the next Warren Buffett, without ever accounting for factors such as maximum drawdown, and the long-term performance of the trader.
But even if you do know how to find a quality trader, most platforms only let you study a limited timeframe, which makes measuring the qualities of traders incredibly hard.
Copytrading platforms are well aware of their target audience, and therefore often advertise the "best performing" traders, sorted by the highest PnL percentage. This is where one of the core problems is, as it creates a conflict of interest. Because traders are rewarded for their copy trading volume, they will do everything they can to get on that leaderboard – including taking excessive risk.
As a result, most of the "top traders to copy" on these copy trading platforms have poor risk management and a very bad track record over the long term. And yet, many unsuspecting investors happily deposit money into these brokerages only to lose it all. The trader makes a commission, whether he wins or loses, (and is rewarded for taking more risks) but the copier stands to lose everything if he messes up.
Vincent Launay (CFA, Blockchain Lecturer at the Washington campus, and Senior Infrastructure Finance Specialist at the World Bank) gives a perfect example of this in one of his contributions to the trading community: "When I see that the trader most highlighted at eToro has a drawdown of 50% daily and 72% weekly, it sends shivers down my spine! The trader certainly makes 600% in the year but if you get there at the wrong time, you can lose 50% of your capital in one day. If there are two negative days in succession, then you won't have much left."
Personal circumstances matter
Another problematic factor is how people base their trades on their own framework of rules, circumstances, environment, and many other things. Traders may be influenced to change their risk appetite, say to fund an expensive surgery, or after the birth of a child. These are factors unique to each trader, and factors that are impossible to know in advance. Copying another trader therefore adds the risk of unpredictable changes to the strategy – based on factors beyond your control.
Moreover, market conditions could change, and the trader you copy could struggle to adapt to these conditions, running down the account. And what happens when the person you're copy-trading all of a sudden disappears? By copying someone else's trades, you fully depend on them, and that's a risky position to be in.
Add to this that many platforms charge a subscription fee for copy trading, and the whole thing becomes a highly unattractive proposition. Instead, your best bet is to invest the time to learn to trade for yourself, or as I discussed in another opinion article, do not trade at all.
Shortcuts do not exist in the real world, and they do not work in the realm of magic internet money either.
Closing thoughts
All in all, copying other traders rarely leads to success. You can use analysis of other traders, but putting your money in the hands of another trader is asking for problems.
In my experience, money can be made in the markets in one of two ways, and copy trading is not one of them. Both ways require you to roll up your sleeves, and get to work. Exercise risk management, and be ready to lose some money. After years of effort, you might eventually come to a level where you're able to consistently make money by trading. If that sounds daunting, your best bet is to take a more passive, long-term approach.
We wish you the best of luck in refining your trading strategies, and we hope this article proves to be useful on that journey.
Author's Disclaimer: This article is based on my limited knowledge and experience. It has been written for informational purposes only. It should not be construed as trading or investment advice in any shape or form.
Editor's note: CryptoJelleNL provides insights into the cryptocurrency industry. He has been actively participating in financial markets for over 5 years, primarily focusing on long-term investments in both the stock market and crypto. While he watches the returns of those investments roll in, he writes articles for multiple platforms. From now on, he will be contributing his insights for WOO as well.
Check out his twitter: twitter.com/cryptojellenl
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