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Is Copying Traders a Good Way to Earn Passive Income?

Blindly copying is dangerous: both in school and when you do trading.

 

With the growing popularity of sites like eToro, more lay investors in Singapore are thinking about dabbling in trading. The prospect seems tempting: all you do is put some money down, and a program imitates an experienced trader in buying and selling (stocks, Forex, commodities, etc.)

Here’s what total beginners should know before they attempt it.

How Does Copying Traders Work?

Copying trading is a tactic used by some newer investors, who don’t have the needed experience. This is as simple as putting down your money, choosing a trader, and then letting a website mimic the chosen trader’s buying and selling with your cash.  The most famous of these are eToro, ZuluTrade, and Currensee.

Most of the time, these sites give those traders an incentive to be copied. On eToro, for example, traders earn small commissions based on the number of people copying them. Note that people who copy other traders can also, in and of themselves, be copied and earn commissions.

On the surface, this seems like a straightforward way to earn passive income. However, there are risks that you need to look out for:

  • You are risking a capital loss
  • Picking traders is not easy
  • Not following trades proportionally is dangerous
  • Copy trading should be a learning tool, not a magic wand

You are Risking a Capital Loss

There’s no way around the fact that trading is a high risk activity. You have to realise that, every day you trade, you’re risking a capital loss – it’s entirely possible to put in S$5,000 and walk away with nothing.

Copy trading should never be equated with financial products such as endowments, Investment Linked Policies, unit trusts, and so forth. Unlike these products, the returns from copy trading will whipsaw, fluctuating significantly every day. You must be psychologically prepared to see huge losses on some days, and if you’re risk-averse this can keep you up at night.

You should never sink your savings or retirement fund in copy trading; only use money that you can afford to lose. And let’s be frank: if you’re the type who can afford to lose money, you’re probably savvy enough that you don’t need to copy other traders.

Choosing Traders to Follow is Not Easy

There can be thousands of traders for you to follow. Picking a “good” trader is not a simple process. You need to consider what they trade in (stocks, Forex, or commodities?), and whether their approach suits you.

If you don’t have much money, for instance, copying an aggressive Forex trader is likely to wipe you out in a matter of days. If you pick traders with 100 per cent win ratios, you may later learn it’s because those traders refuse to close losing positions, instead waiting for the price to go back up (this approach gives the trader a 100 per cent win ratio, while at the same time making them high risk. Those traders are not cutting losses).

Some sites encourage traders and their followers to talk to each other. But however nice and competent a trader might seem, remember those traders (1) get commissions for letting you copy them, and (2) may have little real interest in the welfare of their followers.

Your “trading guru” is not your financial adviser, and won’t avoid taking risks just because it puts followers like you in danger. If you can’t handle the same risks your trader can, that’s your problem – they’re not accountable to you.

(And if those traders happen to be multi-millionaires, their version of a “small risk” might be something that would financially destroy you.)

Not Following Trades Proportionally is Dangerous

Most websites let you follow trades proportionally. For example, the system may set your trades, dollar wise, at a proportion of 10 per cent of whatever your trader buys – so if your trader buys S$100,000 worth of gold, you would buy S$10,000 worth of gold.

A beginner should never, under any circumstance, copy the trader without staying in proportion. For example, if your trader buys S$100,000 in gold, don’t decide “gold must be good”, and then ignore the fixed proportion of 10 per cent and fork out S$50,000 for gold.

Established traders have good reason for vesting different amounts in different assets; the whole point of imitating them is because you don’t understand those reasons (yet). If you are going to copy trade, then make sure you stick to the “copy” part in all respects.

Copy Trading Should Be a Learning Tool, Not a Magic Wand

No matter what you may have heard, copy trading isn’t – and never was – designed to help lazy people magically make money. It isn’t a get rich quick scheme, and it will punish you if you try to treat it as one.

The purpose of copy trading – or social trading – is to help beginners who have a genuine interest in learning to trade. This ranges from finance students, to people who have decided on trading as a career path. Copy trading allows them to interact with experts, analyse various strategies, and develop a better understanding of different trading systems.

That’s the whole reason these sites organise web talks and co-ordinate forums. It’s not just a chatty diversion.

If you really want to educate yourself on trading, then copy trading is a revolutionary learning tool; previous generations of traders would have killed to have it. But if you think copy trading is an easy way to make passive income, then you’ve really got the wrong idea. That’s like mistaking a cooking school for McDonald’s.

 

This article was contributed by SingSaver.com.sg, Singapore’s #1 personal finance comparison website for credit cards and personal loans

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