If you are a newbie investor that simply has no idea how the stocks and shares arena works, you might be considering an ETF or mutual fund. This is because the respective provider will buy and sell shares on your behalf. However, a somewhat new phenomenon has recently entered the space that you might find appealing – copy trading.
In a nutshell, copy trading allows you to ‘copy’ the trades of other investors of the share dealing platform you are using. As such, you stand the chance of making money in the stock markets without needing to research which companies to invest in. Instead, the entire process is passive.
In this guide, we explain the ins and outs of what copy trading is, how it works, and whether or not it is suitable for your long-term investing goals.
What is Copy Trading?
In its most basic form, ‘copy trading’ does exactly what it says on the tin. That is to say, you will be copying the trades of another investor – like-for-like. This subsequently allows you to actively trade the stock markets without needing to have any knowledge of how things work.
It also means that you will benefit from the expertise of the respective copy trader, as they will make each and every decision on your behalf. Best of all, the copy trader will be investing with their own capital – so effectively, this reduces the threat of recklessness.
It is important to note that the copy trading phenomenon is typically offered by a select number of niche stock brokers. For example, it is widely accepted that FCA-regulated platform eToro is a market leader in this particular segment.
Although a number of other providers are also active in this space, eToro and its 12 million users are head and shoulders above the competition – at least in terms of market share.
How Does Copy Trading Work?
As is the case with most online investment streams these days, the copy trading process is actually relatively straight forward.
Below we have listed the general process that you will need to follow – alongside some handy screenshots from leading copy trading platform eToro. The process, does, however, remain largely the same irrespective of the platform you decide to use.
Step 1: Choose a Copy Trader
The first, and perhaps most important part of the copy trading process is choosing an investor to ‘back’. That is to say, you will need to carefully select an experienced investor that you wish to copy like-for-like. After all, your profits and losses will be dictated 100% by the investor’s trading results.
So, if you were to use eToro to engage with copy trading, you will essentially have access to over 12 million investors. It goes without saying that the vast majority of these traders will not have the skill-set nor proven track record to be worthy of copying. As a result, it is imperative that you make full use of the filter facilities.
- The location of the investor (not particularly useful)
- The type of asset that the investor likes to trade (such as stocks and shares)
- The minimum annualized yield and over what period (for example, 10% over the past 12 months)
Once you adjust the filters and hit ‘GO!’, you will be presented with an extensive list of potential copy traders.
Here’s where things get interesting, not least because you will have a significant amount of information at your fingertips once you click on a specific trader profile.
For example, you’ll be able to explore:
Some would argue that this is the most important metric to analyze. Crucially, this gives you a full breakdown of how the trader has performed at the platform since they joined. You need to tread with caution here, especially when it comes to the time frame.
For example, while a trader might be 40% in the green, this might only be based on 3 months of trading. This would indicate that the trader takes significant risks. Instead, you are best advised to stick with copy traders that have a track record of at least 12 months.
Copiers and AUM
You get to view how many people are currently copying the investor in question. If an investor has a large following this is generally a good sign.
You also get to view the investor’s AUM (Assets Under Management). This figure won’t play a major role in the selection process, but it’s interesting nonetheless.
This particular set of statistics is useful, as you get to view the mentality of the investor. For example, you get a full break down of what assets the trader likes to buy and sell. If you are looking to stick exclusively with stocks and shares, you’ll need to evaluate this particular statistic before parting with your money.
You can also view the average profit and loss of each trade. This number is also useful, as it gives you an idea of what the trader typically targets in the profit department. It also highlights to what extent the trader is willing to stay in the red before exiting their position.
At the bottom of the trader’s profile, you get to view some interesting averages. For example, you get to see how many trades the investor typically places each week. The higher the number, the more active the trader is. Similarly, if this is a low number, the investor is likely to favour a long-term ‘buy and hold’ strategy.
Additionally, you can also view the average number of days that the investor keeps a position open. Once again, this will give you a clearer indication of whether the investor prefers more or a short-term or long-term strategy.
eToro will also assign the investor a risk rating, which is frequently updated. The risk meter goes from 1 -10. The lower the number, the less risk that the trader takes. The level of risk that you feel comfortable going with will ultimately depend on you.
Step 2: Decide How Much You Wish to Invest
Once you have selected a trader that you like the look of, you will then need to determine how much you wish to invest. There will always be a minimum investment threshold, which will vary depending on your chosen platform. In the case of eToro, this stands at a minimum of $200 (£160-ish) per copy trader portfolio.
As soon as you confirm the investment – the funds will be taken from your brokerage account balance and allocated into the trader’s portfolio.
Step 3: Copying the Portfolio Like-for-Like
Once you have made an investment, your personal stocks and shares portfolio will be updated accordingly. To illustrate how this works in the easiest way possible, it’s probably best that we give you a basic example.
To keep things simple, let’s suppose that the copy trader has the following portfolio:
- £10,000 worth of shares in Tesco (20%)
- £20,000 worth of shares in HSBC (40%)
- £20,000 worth of shares in Royal Mail (40%)
While it is clear to see that the total value of the portfolio is £50,000 – this number is actually irrelevant. Instead, for the purpose of copy trading, we are more concerned with the ‘weighting’ of the portfolio. In Layman’s terms, this means how much each individual stock contributes to the wider portfolio. This is because your personal portfolio of shares will mirror this weighting like-for-like.
- Let’s suppose that you decide to invest £2,000 into the copy trading portfolio
- 20% of the portfolio would be in Tesco shares, at a total of £400
- 40% of the portfolio would be in HSBC shares, at a total of £800
- 40% of the portfolio would be in Royal Mail shares, at a total of £800
As you can see from the above, your portfolio now mirrors that of your chosen investor – but at an amount proportionate to what you invested!
Step 4: Copying Ongoing Trades Like-for-Like
Once your personal stock portfolio mirrors that of your chosen copy trader, you do not need to do anything else. However, it is important to remember that the investor will be actively buying and selling shares for as long as they remain at the share dealing platform.
In other words, if the investor decides to sell all of their shares in BP, then your BP shares will also be sold. Similarly, if the investors decide to add Facebook shares to their portfolio, your portfolio will also contain Facebook shares.
This is where things get a bit confusing, as eToro copy traders will often deposit additional funds so that they can add more shares to their portfolio. In this instance, you have two options:
Add More Funds
When the investor deposits more funds, you will get a notification. In most cases, the investor will publicly announce that they intend to add more funds, which gives you time to prepare. Either way, if you want to truly mirror the investor like-for-like, you will need to deposit more funds – at a proportionate amount.
- For example, if the investor originally had a portfolio worth £50,000, and they add £10,000 – then they are increasing their position by 20%.
- So, if your portfolio is worth £2,000, you will need to add a further £4,000 (20% of £2,000).
If you choose not to add more funds to your copy trading portfolio, then your position will be readjusted automatically. In other words, eToro will need to sell some of the shares that you currently have, to make room for the new purchase. In this sense, you will still be mirroring the investor, but the weighting won’t be 100% accurate.
How do You Make Money From Copy Trading?
If you have read our in-depth guide on ETFs and mutual funds, then you should already have a firm understanding of how you make money from a copy trading portfolio. If not, you will make money in the very same way – had you purchased the shares on a DIY basis. As such, you can earn money in the form of capital gains and dividends.
- Capital Gains: Let’s suppose that you invest £5,000 into a copy trading portfolio that contains 25 different shares. At the end of year one, the total value of the shares has increased by 10%. As such, the value of your copy trading portfolio now stands at £5,500. If you were to exit your position, your capital gains would amount to £500.
- Dividends: If your copy trading portfolio contains dividend stocks, then you will be entitled to your share. Unlike an ETF or mutual fund, your dividends will be paid as soon as they are distributed by the company. This is great news if you are looking to make use of compound interest. In terms of how much you will receive, this will be proportionate to the amount you have invested in the specific dividend-paying share.
Top Tip: In order to mitigate the risk of overexposing yourself to a single copy trader, it might be worth diversifying across several different investors. You will, however, need to ensure that you meet a $200 minimum investment in each copy trader – if using eToro.
What Copy Trading Fees do I Need to be Aware of?
The fees that you are required to pay when utilizing the copy trading feature will be dependent on your chosen platform. If using eToro, there are no fees whatsoever – so you will still benefit from commission-free stock trading.
All in all, copy trading portfolios are an interesting alternative to other passive income streams like ETFs and mutual funds. This is because you will personally get to select a seasoned trader that you like the look of by analyzing their profile. Moreover, and perhaps most importantly – you get much more control over a copy trading portfolio.
This is because you can adjust your portfolio as and when you see fit. For example, while you might agree with 90% of the trader’s stock purchases, you might not want to gain exposure to the technology sector. If this is the case, you can manually exit these positions and keep the rest of the portfolio active! Similarly, you can also buy shares in any company of your choosing.
Just make sure that you understand the risks of copy trading. Ultimately, just because your chosen investor has an impeccable track record in the stocks and shares space, this isn’t to say that this will be the case indefinitely.
Disclaimer: Investing in shares involves significant risk of loss and is not suitable for all investors. You should carefully consider your investment objectives, level of experience, and risk appetite before making a decision to buy shares. Most importantly, do not invest money you cannot afford to lose.