The copy trading secret…
There is a revolution at hand.
Most people don’t realize it, but technology is once again changing the game.
If you wanted the services of a professional trader not too long ago, you would need to invest in a hedge fund or a managed account. That is, if you could stomach the significant fees and huge minimum deposits.
Lately, there’s a much easier way. By using a copy trading service, you can follow the winning strategies of professional traders. The fees are reasonable, and the investment is only ever what you want it to be.
It’s about access. Access to knowledge, access to expertise, and access to results. Copy trading is democratising what used to be exclusive to the very wealthy. In the past, it was not worth it for a top trader to manage small sums, with all the effort that goes into setting up the account, compliance and ongoing management. Technology – copy trading to be exact – is bridging that gap magnificently.
A few Innovative companies are at the forefront, making the strategies of institutional and ex-bank traders available for you to follow though their copy trading platform.
But that is not the copy trading secret.
The secret is this: Brokers are clambering over each other to get a chunk of this business. So much so that if you conduct your business through them, they will foot most (if not all) of the fees that you would ordinarily pay to the trader.
That’s right.
You pay only a small fee for this service, and the broker will pay the rest.
What’s more, things can only get better. As more in the industry start waking up to the potential copy trading offers, competition for your business will increase, and the deals will get even more appealing.
In this guide, we will cover the ins and outs of a successful copy trading strategy, while teaching you how to manage your risks, so you can make the most out of this significant opportunity.
Read on…
*The typical fee for a hedge fund is 2% of assets under management, and 20% of profits, though this does vary depending on the fund. In addition, most successful strategies have significant deposit minimums of $250,000 or greater.
How copy trading works
Copy trading is, in essence, actually quite simple.
To begin copying the trades of another trader, you simply connect your Forex trading account to the account of that trader using specialist copy trading software (generally though a 3rd party provider. Once set-up, the trades that are placed in the master account are simultaneously placed into your account.
Your account will have a different amount of capital to the master account, so these trades are scaled by percentage to your account size. This means that the returns on the master account will be mirrored (as accurately as possible) in your account, based on your account equity.
In some cases you will may also need to provide an authority/letter of direction for the trader to execute trades on your account.
Note: The trader does not have access to your funds. No one but you has access to your funds. The trades are simply copied from the master account into your account.
Let’s look at an example:
Joe is looking to invest in a copy trading provider, and likes the look of Trader A who has had a return of 292% over the last 3 years*.
To begin following Trader A, Joe first opens an account with a copy trading provider. He then provides written authority for the trader to operate on his account.
Next, Joe funds his account with $10,000 of investment capital. At the same time, the copy trading provider connects his account to the trader’s account, and configures it according to his risk management preferences.
After this, trading commences on his account, and he generates the same percentage return as the master account. In the first month, the trader makes 10%, so Joe’s account is now worth $11,000. In the following month, the trader loses 4%. So does Joe, who now has $10560 in his account, having lost $460.
The returns will continue to be mirrored until Joe decides to close the account and withdraw his capital, which he is free to do at any time. It is important to note that clients can unsubscribe very easily in the back office. There are no lengthy contracts or “lock up” periods like hedge funds and managed acocunts.
*This number is taken from the actual returns of a copy trading provider. Please note that past performance is not a guarantee of future results.
Selecting a strategy
Once you have decided you want to invest in copy trading, it’s time to decide which strategy best fits your needs. Here is the information you will have available to you, and how to make sense of it.
About the Trader
Generally, you will want to follow a trader with a decent amount of industry experience. Look for traders that have five or more years within the industry.
About the Strategy
There are as many different approaches to the market as there are traders, but they do tend to fall into broad categories. Some of these you will want avoid, while others will give your insight into what type of risk vs. reward to expect.
Algorithmic Trading Strategies
Many trading strategies rely on computerized models to determine when to buy and sell. This typically is represented in the EA/Robot market, where clients buy the algorithm for a 1 time fee. These types of strategies can generate significant returns but if the market conditions change, the algorithm may not adapt as quickly as other trading styles or change at all, so there may be periods of losses.
We look for Algorithmic traders who employ discretionary oversight and constantly make adjustments to compensate for market changes. The goal of the program manager will be to run several different algorithms that counter balance each other – so when one is losing another one is winning and vice versa.
Discretionary Trading Strategies
A discretionary trader places trades based on their own analysis of the markets. While they will sometimes use statistical models or algorithms to assist in the decision making process, generally they take into consideration both fundamental and technical factors before making a decision to place a trade.
A good discretionary trader will have years under their belt, as well as a carefully crafted and comprehensive risk management framework. Discretionary traders don’t always generate the same kinds of returns in the short term as algorithmic traders, but they do tend to be consistent and reliable so you may feel comfortable investing larger sums in discretionary trader with good track record.
Martingale – Stay away
Firstly, there are some strategies that you may want to sidestep. Anything that includes a “martingale” style money management model is dangerous. These types of strategies “double down” when they are losing, but this can only last for so long, before a trend will cause a significant loss.
Maximum Drawdown
An important consideration in selecting a copy trading provider is the previous drawdown that the system has experienced.
While it would be nice if our investments always went up in value, that is not the reality. They all go through losing periods on occasion, before recovering to new highs. When a system is in one of these losing periods, it is called a drawdown.
When assessing the copy trading profile you want to engage, look at the maximum drawdown and see if it fit your personal risk profile. Generally you would look for a drawdown of no more than 40% at most, with around 20-30% preferable. Some drawdown is inevitable, but it’s important to limit this based on what you’re comfortable with.
Having said that… be careful not to throw out the baby with the bath water. It is quite possible for an excellent money making strategy to have suffered a drawdown due to a market event. That does not mean that the strategy is not going to perform in future.
Always reach out to your signal or system provider to discuss any questions with a particular drawdown.
Below are some skills that will help you manage drawdowns effectively.
| Note: You can effectively alter the drawdown profile of a strategy by allocating less funding to the strategy. For example, if a program has a drawdown of 30%, you could allocate it half of the normal amount, effectively reducing your overall drawdown potential to 15%. Of course returns would be halved in that case, too. This can sometimes be done by editing the settings in the copy trading back-end, rather than by moving funds to and from your account. |
Understanding Returns
When you assess a trader, you will see monthly, weekly, and annual returns per trader. Of course the greater returns the better, but you must consider this alongside the maximum drawdown.
For example: if one trader returns 100% with a 40% maximum drawdown, they will have the same risk profile as a trader with a 50% return and a 20% maximum drawdown.
Look for traders with a proven track record of consistent returns over a period of time. Don’t judge a program but any performance outliers. If a program is up huge or down huge in one particular month it could be due to a extreme market move. Base your analysis on the historical performance collectively.
It is also helpful to look at the biggest winning and losing months to get an idea of what to expect from the system.
Understanding the equity curve
One way to tell if a trader produces consistent returns is to look at the equity curve.
The equity curve is simply a graph of performance over time. The smoother the equity curve the better, as long as it is sloping upwards of course!
For example, you can see the equity curve taken from myfxbook:
In this case, the equity curve shows that the trader continues to grow his account consistently over time.
How long the strategy has been trading
The longer a strategy has been trading, the more it is proven to stand up to different market conditions, and the more confidence you can have investing in it.
While sometimes it can be good to get into a new program while it is running “hot” you will want to have very tight risk management rules in place. This is the topic of the next section.
Understanding MyFXBookWhat is Myfxbook? Myfxbook is an online automated analytical tool for forex traders. It supports over 100 brokers, enabling clients to track, compare, verify, analyze and share live and demo trading results/activity. Trade data is posted on their live servers to allow clients to see authenticated results in real time. Why do we use it to verify performance? We wanted to find the most transparent and widely accepted means for individual clients to view live results on any trader we post – for FREE. As a totally independent 3rd party, there is no conflict of interest. Thus, the results don’t lie. If it is posted on the site on a live account, it happened and there is no way to change or hide any details. Real time reporting allows clients to see audited style results without having to wait for the auditor on a monthly basis. Here is a breakdown of the terminology you need to know when using myfxbook: “Gain” – total historical performance of the program. “Drawdown” – the total amount the program has ever gone into the negative. It measures the largest single drop from peak to bottom in the value of a portfolio (before a new peak is achieved). “Track Record Verified” (with a green check mark) – is visible when the data myfxbook receives matches the data supplied by the broker about the live account. “Monthly” – average percentage of Historical “Gain” divided monthly “Real” – is the term that refers to a live account with real money at a particular broker (not a demo account). “Profit Factor” – is the sum of winning trades vs losing. The higher the number the better. “Monthly Analytics Tab” – this is a good way to look at the monthly historical results to gauge momentum / consistency of the strategy. |
Mastering the Art of Managing risk and Protecting Profits
The best traders are risk managers first, and traders second. Before they worry about profits, they take care of how they manage risk exposure and losses. This is the approach that you should take as well.
“You are a risk manager first and a trader second”
Remember, although you have another trader placing trades on your behalf, you are still ultimately responsible for your own profits and losses. Think of it like you are a money manager, allocating your funds to other managers to trade.
You will still have rules around how much you will allocate to each strategy, what returns you expect to achieve, and how much of a loss you would be prepared to take before you withdraw your funds from the trader.
Having a plan like this will allow you to invest with confidence.
How much funding to allocate to a trader
Your first decision as a “risk manager” is to decide how much capital to allocate to copy trading.
Copy trading is considered a high risk/high reward investment strategy. While the potential returns can be large, there is also the risk of loss.
Because of this, generally a small portion of your overall portfolio should be allocated to Copy Trading. While we cannot suggest what the right amount will be for you, there are minimum investments that are typically used by each copy trading provider. These suggested minimum amounts are listed in the profiles we include later in this report.
The good news is you can get started with far less than what you would have had to in the past, investing in a managed account or hedge fund, with minimum amounts starting at around $1000 for some strategies.
Managing drawdowns
A drawdown occurs when there is a loss from an equity high in an account. For example: if your account had lost 5%, then it would be said to be in a 5% drawdown. Drawdowns are part and parcel with trading and are to be expected and planned for.
There are two types of drawdown that you might experience. The first is a drawdown on your initial investment. As an investor, it is critical that you protect your “core capital” – otherwise you cannot continue to invest. For example, if you invested $10,000, and your account drew down to $9,500, this would be a drawdown to your initial capital.
The second type of drawdown is a drawdown to your profits. For example: if you started with $10,000, went up to $15,000 and then had a drawdown to $14,000, you would have a drawdown to your profits.
Both types of drawdowns require slightly different management techniques. As an example, you might be less willing to risk your core capital and more willing to risk your profits. This is a good example of the old investing adage “cut your losses short, and let your profits run”.
“Cut your losses short, and let your profits run”.
To do this, you first need to understand the previous maximum drawdown the trader has had. For example, a trader may have had a drawdown of 20% previously. This will be a good guide of what to expect.
This means that in the long-term (when you have some profit), you might be quite happy to keep following the trader as long as they don’t go beyond the 20% drawdown threshold from the highest point.
But for your initial capital, you may not want to allow this. Instead, you might allow for a 5% drawdown, after which point you might cut your trade size in half (you can do this though the copy trading service) until your loss is recovered.
You might then allow for another 5% drawdown at the smaller size, before stopping trading. That means that even if the strategy does have a 20% drawdown, you will have lost only 10% of your initial capital, leaving you in good shape to allocate your funds to a better performing manager.
While the likelihood of this scenario is relatively low, it is better to be prepared. While the numbers above serve as an example, you will need to determine the right number for you based on your investment objectives.
Taking profits
Key to an effective money management plan is having rules for profit taking.
Over time, your copy trading investment is going to produce profits, which need to be managed just as your risk does. Again, when developing your profit taking plan, you want to think about your objectives.
While it may be tempting to simply “shoot for the stars”, over the long-term this is going to mean you end up leaving money on the table. All traders run hot and cold, and it’s your job to make the most of it when they run hot… and then keep your profits when they run cold.
There are several ways to design a profit-taking plan, and here are some considerations to take into account:
- What percentage of your profits do you want to withdraw, as opposed to leave in to compound? Compounding your account is an excellent way to grow your investment, but it needs to be balanced with a prudent approach to locking in your gains.
- How often will you withdraw profits? You may decide to withdraw some profit each month, quarter or year.
- Will you withdraw profits based on a percentage return figure? For example, will you take profits out when your account is up by 20%? 30%? What are your goals?
- How will you handle a large windfall profit? For example, a trader may have an exceptionally good month, and it may be prudent to take some of those profits.
- How much of your profit might you be willing to give back, before you withdraw some? For example, if a trader has a 5% drawdown, you might use this as an indication of when to take profit.
As a professional investor, you want to design a method of profit taking that uses these considerations to achieve your goals, and not be too cautious or greedy. In other words, it’s best not to leave it all in, and it’s best not to take it all out. Your job as an investor is to find the line.
When to stop following a trader
You don’t need to wait until a drawdown level is hit before you stop following a trader.
In fact if you understand the expected performance of the strategy, you can cut your allocation, or stop following a trader, if their performance falls outside of expectations.
For example if a trader typically has returns of +3 to + 10 percent per month, and all of a sudden he has 3-4 months with returns in the negative, you might want to cut back your allocation and consider restoring it gradually over time as results improve again. This limits your risk in terms of that trader, and frees up some capital to be allocated elsewhere if this is in line with your investment plan.
We always tell investors to set their own drawdown level. It is good to use the actual historical numbers as a barometer, but also have a number in mind as a personal risk threshold. You will want to get out when/if a trader hit that number whether it is smaller or larger than the actual systems historical Max DD number.
Important note – if your risk threshold for a Max Drawdown is less than 10% then this may not be the right investment for you. Investing in the currency market is high risk and involves understanding the risks. There will be equity fluctuations + or – 10% in any high risk investment opportunity.
Creating a copy trading portfolio
One of the best ways to limit your risk and improve your returns is to diversify across a number of traders.
Ideally, you want to create a portfolio of non-correlated trading styles and strategies. In simple terms, what this means is that when one trader is not performing, you have another trader that is making up for it.
This will help you to have what is called a smooth equity curve:
When choosing your “basket of traders” you want to consider the following:
- Do the traders historically have non-correlated returns? Take a look at the winning and losing months of the traders and see if you can find ones that tend to win while others are losing.
- Do they use different trading styles such as discretionary, algorithmic, trend following, counter-trend? It is good to have a mix of styles and approaches.
- How many traders to have in a portfolio? While it is good to diversify, you need to make sure you have enough capital to allocate to each trader so any expenses are covered and you have the potential for profits. This may mean if you have a small account you need to stick to one or two traders at most.
But most importantly, you want to take time to answer the “how much” question.
How much to invest in each trader?
It is the “how much” component of your investment strategy that determines if you achieve your objectives or not.
When deciding how much to allocate to each trader, you could split your funds evenly across each trader. But this might not get you the desired effect of balancing one trade against another to diversify your risk and performance.
A more effective way to allocate capital is consider the risk vs. returns profile of the trader.
Look to understand the previous drawdown and returns, and allocate capital to even out the impact of each trader on your portfolio. For example, if one trader’s returns and drawdown are typically twice as big as another’s, then you might allocate half as much to that trader. This ensures that any one trader does not have an outsized impact on your returns positively or negatively. Remember that smooth equity curve you were after? This is central to how you get it.
Rebalancing
Running a portfolio of traders requires some active management.
As one trader makes profits, their proportion of your portfolio will increase, leaving it “unbalanced”.
To counteract this effect, you may want to rebalance your portfolio. This could be done simply by taking some profits out of your account, or by moving funds from one copy trading provider to another when things become uneven.
Perhaps you could schedule this on a set timeframe, such as every three months, or you may decide to rebalance when a trader’s returns increase past a certain point.
Our favorite copy trading provider
For copy trading we recommend you check out Back Bay Forex.
Back Bay Markets consists of an experienced team of Forex veterans who work through an established network of Banks, Brokers, Introducing Brokers, Money Managers, Signal Providers, and partners around the globe. They have cultivated these relationships over the past 10 years and leverage these connections for their investors.
Back Bay Markets is at the forefront of the copy trading revolution. Their vision is to use copy trading to “democratize” access to professional money managers.
They have made a science of matching professional traders with retail clients. By using their existing relationships from years in the Forex industry, they are able to get access to ex-bank traders, professional fund managers, and talented independent traders around the globe.
This, combined with thir technological edge and rigorous vetting process, leaves us in a unique position to change the game in your favour.
To check out Back Bay Markets signal providers you can click here.
About the Author
Sam Eder is a currency trader and author of the Definitive Guide to Developing a Winning Forex Trading System and the Advanced Forex Course for Smart Traders. He is a part owner of Forex Signal Provider fxrenew.com (You can get a free trial). If you like Sam’s writing you can subscribe to his newsletter for free.
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