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Social trading is an innovative way to access the financial markets without the need to be well versed in analysing them. What you do instead is access a list of top-performing traders who are sharing their trading results and copy their strategy in your account.
When it comes to social trading, the most common question is whether it really works. When your hard-earned money is on the line, it is important to understand both the benefits and risks that come with social trading.
But most of all, you need to understand that it is not about analysing the markets anymore. It is all about learning how to analyse performance and manage your risk instead.
As with trading, copy trading also requires you to create your own trading strategy. The specifics will depend on your individual profile, including how risk averse you are, how long you plan to commit to copy trading etc. No matter what your preferences though, every copy trading strategy involves three key factors that you need to pay attention to in order to improve the odds of a stable performance of your copy trading, while reducing the risks associated with following other traders and their strategies.
When you login to the ZuluTrade Platform, you see a leaderboard of traders categorized based on performance. As tempting as it might be to simply go for the ones topping the table, remember that when evaluating performance, profit percentage is a good indicator to start with, but you will have a better understanding of their trading results, if you also look at other factors, such as maximum drawdown.
A good track record is one thing to look for, but a good track record over time is what you are really after when evaluating a trader. Make sure to follow traders who have enough experience and a solid backlog to their trading strategy that will ensure that it has been tested throughout both volatile and ranging markets. Investment professionals normally don’t accept a track record shorter than 6 months and most demand 12 or even 24 months of performance before committing their own funds to a trader.
A second aspect to look out for is asymmetric risk, meaning when a trader’s losing positions are much larger than their winners. Statistical models point out that such traders are more likely to blow-up over the long run. The opposite is also valid - traders that book larger profits when compared to their losers are more likely to survive in the long run.
And when it comes to the numbers, return on investment might be the percentage that draws all the attention, but maximum drawdown is an equally important indicator for the long-term performance of your copy trading.
the longer the track record, the more reliable it is
the smaller the maximum drawdown, the less likely it is for you to lose a significant portion of your funds
Always note the amount of money that the trader is managing. If the size of the account the trader manages seems small compared to the amount you intend to invest, be aware. The downside of investing your money with other traders is that the ways they manage risk is different to what you use when trading yourself. As a rule of thumb, the more “skin in the game” a trader has, the more confident you can be in the success rate of their strategy.
Simply said, do not put all your eggs in one basket. When copying traders, make sure to diversify between different strategies. Some are more effective than others, and naturally riskier. Following multiple strategies grants you the opportunity to take advantage of different market conditions and mitigate risk. Some traders make money in volatile markets, while the strength of others is in range trading.
Know the assets the trader is engaging in
Choose more than one trading strategies to follow
Allocate less money to riskier strategies
Copy trading is an automatic process, but this does not mean that you can choose who to follow, commit your funds and then forget about it altogether. Traders may choose to change their strategy or may go through a period of underperformance. That’s why you need to evaluate the traders you follow every couple of months in order to avoid the below red flags:
Traders who drastically and frequently change the size of their positions. Consistency is key!
Traders whose average winners have become materially lower than their average losing trades
Traders whose balance has run low
Knowing how to manage risk is essential both in trading and copy trading. Experienced traders often use the so-called 2% rule - the amount of money they risk per trade is 2% of the value of their account. This rule helps manage risks and ensures that one bad trade doesn’t materially hit the trading account’s value. But with ZuluTrade, you don’t have to do all the risk management yourself.
One of the reasons ZuluTrade has become a popular platform within the copy trading community is because they have created a set of sophisticated tools to help traders with risk management. These include Single Trade Protection, ZuluGuard and Traders Combos. Single Trade Protection is a stop loss function per trade. You can specify the maximum loss in pips that you’re willing to tolerate or the maximum open trades a particular strategy is allowed to open on your account.