The Hidden Costs and Risks of Copy Trading You Need to Know

The Hidden Costs and Risks of Copy Trading You Need to Know

Copy trading isn’t a shortcut to successful investing. Here are the challenges a novice copy trader would go through. 

Copy trading has been gaining popularity in the world of finance as an investment strategy where one trader’s position is automatically copied by another trader’s account. With numerous platforms available, both in the cryptocurrency and foreign exchange (forex) markets, it has become easier for new investors to copy the investment strategies of seasoned investors. 

If this is the first time you’ve heard about this, you might be thinking that this is a surefire way to make money as a newbie trader. You can follow someone who has more knowledge of the area than you do and avoid the tedious task of monitoring the movement of stocks. However, copy trading isn’t quite as simple as it seems. Here is a look at the disadvantages of using copy trading as your main investment strategy. 

The struggle to find the right trader to follow

The first thing to consider with copy trading is the effort required to find the right trader to follow. You will have to spend a lot of time researching the strategy of a trader and their track record. This would probably be just as time-consuming as learning about the market itself. Even after you have found a trader to copy, you are entirely reliant on their investment strategy. While the trader you choose might have had big successes in the past, they probably also experience losses. And if you follow this trader blindly, so will you. 

The added costs of copy trading

Investing in copy trading may not be as cost-effective as you think. It can turn out to be more expensive than traditional investing because of the fees charged by copy trading platforms. Certain platforms may charge you a fee to open an account or withdraw funds, which can add up quickly. If you are a novice trader, you might miss out on the fine print only to realize that these costs are eating away at your profits when you try to pull out your money. 

Limited learning possibilities 

One of the biggest drawbacks of copy trading is the limited learning opportunities it offers. While copy trading is an easy way to invest your money, it doesn’t give you any opportunity to develop your own knowledge base about the market and figure out your own financial strategies. This lack of knowledge can also make it difficult for you to understand why the trader you are copying is buying or selling stocks, hindering your ability to become an independent investor. 

Liquidity risk

One potential risk of copy trading is liquidity risk, which can arise when the trade you are trying to copy cannot be executed at the same price point or at all as the original trade. This problem can happen when there are not enough people interested in selling or buying the asset you are trading. This can occur due to market inactivity or when the trade is happening outside routine trading times. Such liquidity risk is more prevalent when trading illiquid assets like exotic currency pairs or low-cap stocks.

Dependence on technology

When you use copy trading platforms, you are leaving your hard-earned money at the mercy of technology. However, there are a host of things that could go wrong with relying on technology. For one, the internet could be unreliable and prone to outages, and even the best trading platforms could experience glitches or crashes. In addition, your trade might not go through simultaneously because of a lack of funds, leading to missed opportunities and losses. 

So should you just swear off copy trading?

If you are still enamored with the idea of copy trading, the first thing you should do is learn about the different kinds of investment strategies that professional traders use. This will help you understand why a trader is making certain decisions and, thus, make you more adept at choosing the right trader to copy from. To diversify your portfolios, it is also important to pick different investors to copy for different projects, such as copying one trader for forex investments and another for penny stocks. 

You can also consider mirror trading, an alternative to copy trading, to have a bit more control over your investments. Mirror trading essentially means following the same strategy as a veteran trader but not copying their exact investments. For instance, if you want to practice value investing, you can mirror Warren Buffett and apply his rules of investing to your own portfolio. 

Ultimately, remember that investing inherently comes with risks. Hence, no matter which strategy you choose—copy trading or learning everything all by yourself—you do stand to lose money. While copy trading can be a useful tool for novice traders looking to learn from the strategies of more experienced investors, it is important to carefully research and choose the right traders to copy. Before you go into copy trading, make sure you understand the potential risks involved in the process. 

This article is meant for informational purposes only. Please make investment decisions based on your own discretion. 

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Header image courtesy of Envato.

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