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Copy trading and Risk Management

All Eggs in One BasketEffective risk management is the foundation of all successful online trading and investing. In fact, it’s fair to say that it’s the key to any investment or even any activity in life. A lot of people get caught up in the excitement of opening a trading account and the very real possibility of making money. Their enthusiasm is understandable, but they sometimes forget that investing in the financial markets is inherently risky and that it’s possible to lose money on any trade.

Successful traders work systematically to reduce the number of risks involved in trading and keep unpleasant surprises to a minimum. Some losses are inevitable (even for top investors like Warren Buffet and George Soros) it comes with the territory. The challenge is to reduce the number of losses to a level where they are consistently outweighed by profits. There are some investors who manage to do this month after month. And using social and copy trading you can now connect to them directly and copy their investments.

The Basics of Copy Trading

Copy Trading Together BetterCopy trading is a revolutionary system that is being pioneered by a small number of online brokers. It allows so called ‘social traders’ to directly copy each other’s investments and profit whenever the person being copied profits. This is done automatically by setting your trading account with a single click.

There’s however a misconception that copy trading is mainly beneficial for new and inexperienced traders. In fact, copy trading is potentially a superb investment tool even for highly experienced traders, and here’s why …

Diversify your Portfolio

One of the first rules of risk management is diversification. If you invest all your funds in a small number of core assets you are placing yourself at the mercy of the markets – this is seldom a good place to be – unless you are a hardcore day trader or scalper. If your assets crash you will lose your money. If you maintain a diversified portfolio with a wide range of assets you will be less vulnerable. For example, a currency may suddenly fall in value causing you losses, but share prices and gold may rise at the same time, bringing you profits. The idea is to be covered through exposure to a wide range of assets with different risk levels.

Social Trading DiversificationCopy trading can be a fast and effective way to obtain that level of diversification. When you copy another trader you are normally copying all their investments. Even a small number of copy trades can expose you to a large number of assets, including stocks, currencies, commodities, indices and ETFs. And obviously when you also trade yourself, it exposes you to the trading skills and insights of other successful traders, meaning diversification against your own trading results (and let’s face it, nobody doesn’t have the occasional bad run).

Copy trading is not a random process, you need to select the traders who you copy as carefully and as systematically as you choose the ordinary assets that you trade. All social trading networks and brokers provide you with search filters to find other traders. Some brokers like eToro even allow and encourage you to talk directly to their top Popular Investors and ask them questions about their investments.

Every trader is normally also assigned a numbered risk level that changes to reflect their historic trading activity. Depending on the platform you can also see all their open trades, trading history, a lifetime graph showing monthly profit and loss and their News Feed dialogues with other traders. Copy trading allows total transparency (without compromising on individual privacy or account information).

Practice Additional Risk Management

Risk Management with Copy TradingThe financial markets are vast, spanning continents and time zones. Even experienced traders are unlikely to have specialist knowledge of all the different assets and niche investments that are available to online traders. Copy trading allows you to identify the experts and learn from their investments. The process comes with its own risk management tools, specifically “Copy Stop Loss”. You can decide in advance what is an acceptable level of loss for any particular trader (or trade) you copy and set your account to automatically close the copy trade if that level is exceeded. The “Copy Stop Loss” tool takes away the need to continually monitor your copy trades. You can let them run in the background – even for days if necessary – and check them at your convenience.

A number of analysts and financial commentators are already saying that copy trading is the future of online trading. Social traders are very receptive to the combination of Facebook style News Feeds and open communication with other traders from across the world. Many experienced traders are now also realising that it’s also perfectly possible to earn a second income in return for “being copied”. Which is of course also good news for investors looking to find profitable traders to copy.

The earning potential varies per network. eToro’s Popular Investor Program for example is currently paying its best Popular Investors up to 2% on the AUM (assets under management) as monthly cash payments. And with some of their top traders having over $300,000 in assets under management the extra earnings potential is clearly visible.

Copy Trading In Brief:

  • Risk management through diversification
  • Filter potential copies by risk level
  • Reduce risk using Copy Stop Loss
  • Learn to trade new assets and markets
  • Get paid for being copied by others

Copy trading offers traders of all experience levels the opportunity to quickly build a diversified personal portfolio and learn about new investment opportunities the easy way. Those who persevere and develop a strong public profile can attract copiers and earn more money. Most traders have the potential to reduce the element of risk and invest more effectively.

Please note that:

* All trading involves risk. Only risk capital you’re prepared to lose.
* Past performance is not an indication of future results.

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