Trading the markets can be a tricky business at the best of times. This can be particularly off-putting for new traders as they navigate how to get started. To complicate things further, newcomers are regularly exposed to a flood of self-styled experts with many offering contradictory advice.
To be on the safe side, many new traders turn to social or ‘copy’ trading, following the lead of other more knowledgeable and experienced players. Others prefer to take their cue from trading signals — whether generated by human technical analysts or algorithms— that provide detailed trade ideas about when and where they should buy and sell.
Confused yet? Don’t be. This article will break down what is involved in these two different approaches and how they should be used. Hopefully it will help you decide which route is best for you, particularly if you’re just starting out on your trading journey.
What is copy trading?
Copy trading is somewhat controversial, but the logic behind it is simple enough. A trader mimics the trades of others who are more experienced and market-savvy. In copying a ‘master’ trader, you can save time and effort in analyzing the situation yourself. You can see the trading records of these ‘master’ traders, and then choose one or more to follow and copy. It’s no surprise that many traders, especially those new to the business, have found this option rather appealing. After all, what could be better than putting your feet up and leaving the hard work to someone else? All you have to do is sit back and count your winnings. But is it really that straightforward? We explain why it may not be later in this article.
A favorite market for copy trading is foreign exchange (Forex). With a copy trade option for trading Forex, you simply choose an amount you’re willing to risk from your account and then select the option to automatically replicate a master’s trades. This can also be done manually, but the same basic idea — imitating another trader’s position — still applies. The amount you risk is up to you. It does not have to be identical to that of the master trader as you choose the percentage of your account balance with which you wish to trade..
What are trading signals?
Unlike the blind mirroring involved in copy trading, trading signals are passive in that you choose whether to set up each individual trade idea or not. The signals come from technical analysis and the methodology behind each idea is laid out clearly. This analysis can be done by humans or algorithms. But in each case, a range of technical indicators and drawing tools are used on price charts to formulate the ideas. Each trading signal will advise you on where to buy or sell a given financial market, where to take a profit, and where to place a stop if things don’t work out. The rationale behind each trade idea is articulated clearly with the most common markets studied being Forex, stock indices, and commodities.
Which strategy is right for a new trader?
Copy trading helps traders save time and effort. You don’t need to learn how markets work. Instead, you just plug in, deposit your money and let someone else take control.
If you were waiting for the ‘but’, here it is. Copy trading is not a guarantee of success, and things can go awry. Trade Nation emphasizes that “even if a ‘master trader’ is enjoying a good run, things can change in an instant. And if you’re copying them, your trading account will be drained too”.
What’s more, many naive and uninformed investors have seen large sums of money disappear after following the trade ideas of less-than-credible ‘masters’, particularly on social media channels. At the end of the day, copy trading does not promote critical thinking on the part of the individual trader, leaving them vulnerable to paying for others’ mistakes by virtue of simply imitating them.
Trading signals can be incredibly useful tools. They offer up solid trade ideas along with a defined plan for managing risk. They always come with a price limit for opening the trade, together with a suggested stop-loss order which will cap your potential losses if the trade doesn’t work out.
The signal provider may also give you updated information and advice, often with clear reasoning for taking the trade in the first place. The onus is on you to study and think through the recommendations which come from the trading signal. This is a good thing as it lets you independently figure out which action is right for you. It also helps you to learn and understand how markets work and how prices move and relate to each other.
That said, just as with copy trading, the insights and suggestions are fallible. At the end of the day, nothing can be certain when it comes to trading, and even the best analysis can result in incorrect signals.
In addition, while trading signals give you room to exercise your independent thinking, they can foster a certain level of dependence. This can be a crutch that stops you from building up the necessary trading knowledge to become a truly independent trader. But there are some key decisions that you will have to take for yourself. These involve understanding which financial markets are the riskiest, and how much you can afford to stake on one trade. For that, you need to develop a solid trading plan, using signals to improve rather than determine the trades you make.
Which strategy is right for you?
Both copy trading and trading signals have been used successfully by plenty of traders. In that regard, they are both examples of passive tactics for making money. But neither is a substitute for a more long-term approach to the markets. You may stand a reasonably good chance of winning trades and making a profit. But as any investor worth their salt will remind you, this does not lead to a better understanding of the fast-moving world you’re trying to navigate.
In reality, there are no shortcuts to being a competent, independent trader. It demands your precious time and effort, to focus and concentrate on the markets, and to understand the importance of strict risk and money management. It may all take time and effort, but most traders agree that it’s worth it in the end.