eToro’s Copy Trading: How and Why it Works

Copy trading... how it works
Copy trading... how it works © forexop

A Little Bit of History

The internet has been a great leveler and no more so than in the realm of finance. Many people fail to realize just how much the financial markets have been transformed in the last few years – both with the move to fully electronic trading as well as the internet opening up access to the wider public.

When I started my career as a derivatives trader, access to the markets was almost exclusively the territory of large financial institutions and wealthy clients. Even if you’d wanted to trade forex, stocks or bonds for example, access to the market was so exclusive and restricted in those days you’d have needed your own broker.

Today, not only can you trade with a few dollars, you can trade using other people’s time, other people’s strategies, and other people’s experience. That’s what eToro’s copy trading is about.

In the olden days before the web Buying or selling any financial instrument involved telephoning your broker and speaking to them in person. They in turn would call their representative trader on the floor of the exchange or a market maker who’d execute the trade on your behalf.

The whole process could take anything from a few minutes to a few days (depending how reactive and available your broker was).

Is social and crowd sourced trading: the future?
Is social and crowd sourced trading: the future? © forexop

Not surprisingly, for private investors, dealing in this way was very expensive, time consuming and not without risks. In those days, the idea of day trading the markets with a few dollars was unimaginable.

Because of the manual process involved, brokers were only interested in dealing with clients holding accounts worth millions of dollars.

Social investing comes of age Today, not only can you trade with a few dollars, you can trade using other people’s time, other people’s strategies, and other people’s experience. In other words, you can have your very own team of traders working for you. Not only that, they are working for you for free. How is that possible? With eToro’s copy trading, which I am now going to explain.

If you haven’t already come across copy trading, I suggest you read on. It could be one of the most important developments in financial investments in recent years.

How Does Copy Trading Work?

Before I get into copy trading per se, a bit about eToro the company. eToro is an online broker, but not just any old online broker. eToro offers what they describe as a “social trading platform” (read the full review here). eToro’s open book network (profile pages) means that the portfolio and trade history of every trader is available for all to see on their profile page. If you think, Facebook for traders, you’re not far from the mark.

While everyone’s portfolio details and statistics are openly displayed, the exact dollar amounts invested are not. If you invest in eToro, nobody will ever know how much your account is worth – unless you tell them.

Copy trader popup screen
Copy trader popup screen © forexop

eToro have now taken this idea a step further: On the profile page of every trader, there are two actions that you can choose. Follow or Copy. If you follow a trader, you’ll receive any updates, and details of each and every trade he or she does – a bit like Twitter updates.

If you choose copy, you will automatically copy, like for like, every trade executed on their account.

Let’s consider an example: At forexop, we always test out several scenarios. When you choose to copy a trader, you’ll be asked to specify an amount to allocate to them. Say for example you choose to allocate $1,000 to trader Bob. This means that initially trader Bob has at his disposal, $1,000 of your equity.

Say Bob executes a trade worth 10% of his equity. When this happens, the same trade will be instantaneously executed in your account for 10% of the copy amount $1,000; that is $100. Everything happens automatically and transparently – both for you and Bob. When Bob closes his position, yours will also close and you’ll realize proportionally, the same profit or loss that Bob does.

Just like when you buy units in a mutual fund or a PAMM account, the amount allocated to trader Bob will increase if he makes a profit. So say after a few weeks he turns a profit of 50%, the amount allocated to him increases to $1,500. Of course, if he made a loss, the amount would reduce.

One drawback is that you have no way of knowing how much of their own money a trader is playing with.

Copying open trades: When you copy a trader, you’ll be asked if you want to copy his or her existing open trades.

Note I advise great caution here. Always review the open trades as well as their full history – if those open trades are all recent, all well and good.

However be wary if there are historical trades (going back several months) with unrealized heavy losses. These are most probably bad positions which the trader entered into in the past and is reluctant to realize the loss on.

The last thing you want is to take on these losing positions. Having lots of unrealized losing trades could also be a sign that the trader is misjudging their entry points – you might want to reconsider copying such a trader.

If you think the positions are recoverable, you can always copy them and take control yourself. This is important since you may be able to manually close with profit, which the trader would be unlikely to do if he mistimed his entry point and is sitting on a large loss.

If you do copy such trades, I advise entering your own stop losses and take profit levels (which will automatically remove the copy).

How To Choose Profitable Traders

With around 2.5 million traders to choose from on eToro, selecting the best can be quite a daunting task. Fortunately, I have some pointers which will help you to select those traders who are most likely to deliver consistent, profitable returns over the long term. Here are the criteria I use:

  • Must have at least 12 months trading history
  • Must be active (at least 1 trade per week, over the last 12 months)
  • Must have a consistent performance with no drawdowns greater than 25%
  • Must have an annualized return (realized profit) of at least 25%
  • Must be at least 95% manual
  • Must have at least 85% win ratio
  • No more than 20% high risk trades

There’s a filtering tool provided on the eToro openbook that allows you to screen traders by a whole range of different criteria. In addition the quick settings will take you straight to commonly searched screens, such as high return, low risk. You can apply these settings to any of the given time frames.

Beware: When reviewing a trader, always check their trade history to make sure their performance is consistent. It’s very common on eToro for people to rush in to copy traders just because they’ve achieved astronomical profits of 3-4,000% over a few weeks. In all likelihood, this will have been down to a few small, but highly leveraged trades that went their way (always check their performance chart for smooth, consistent returns).

Performance chart showing total gain over 12 months
Performance chart showing total gain over 12 months © forexop

Remember You have no way of knowing how much of their own money a trader is playing with. For all you know he or she could be using pocket money. In my opinion this is the main drawback of the system (along with the fact that you can’t set stop losses on a trader). If I’m investing my own hard earned cash, I’d at least like to know the trader isn’t just playing for beer money.

Copying copiers It’s entirely possible to copy traders who themselves are copying other people. However, before doing so, always check precisely who they are copying (look in the portfolio section) to make sure you are not duplicating trades by copying the same person more than once.

Diversify

eToro allows you to copy up to 20 traders at a time. You can allocate up to $50,000 per trader or 20% of your total equity (unless you modify your settings). Naturally you should aim to diversify your portfolio of copy traders. You can also decide the allocations based on your own personal risk/reward appetite. For example, you might want to allocate a higher amount to consistent, but lower profit traders, and a smaller amount to high-risk speculative players.

Portfolio breakdown with copy trading
Portfolio breakdown with copy trading © forexop

Why Copy Trading Works

It’s hardly surprising that a lot of the most consistently profitable “traders” on eToro are not trading at all – they are copying other people. In fact, you don’t even need to know anything at all about trading to use this approach.

In this respect, copy trading is more like having a managed (mandated) account or investing in a number of funds. If you think about it, the implications of this are astounding.

Compare for example the process of investing in a managed fund. Typical fees are:

  • Manager’s fixed fee
  • Front load (placement fee)
  • Manager’s performance fee
  • Market maker’s spread, for traded funds and structured products
  • Secondary fees: Hidden internal trading costs, and taxes depending on the fund domicile
  • Your broker’s fee
  • Your own local taxes

By the time you see your profit (if you’re lucky), the brokers, tax men, fund managers, market makers, and investment advisors have already taken out their own, very substantial, cut. Apart from the performance fee, they win in any case – regardless of whether you do! Their interests are not fully aligned with yours.

Not only that, many of the top funds only allow purchase or redemptions monthly, some even quarterly. The top hedge funds, and the premier managed accounts typically have minimum investment requirements of $1 million or even as much as $5 million.

In the financial crisis of 2007-8 investors discovered to their dismay that many of these highly paid investment managers where simply not worth their salt. Many funds crashed losing up to 90% of their value.

In a lot of cases, the managers’ performance was far worse than the markets as a whole. In fact, when the crunch came many top paid managers proved to be no better than amateur investors at protecting their clients’ wealth.

Given these facts, now and beyond, why trust your money to a highly paid team of investment managers and middlemen, when there’s a far better alternative?

Now compare the above to eToro’s copy trading system:

  • You have direct access to the market 24×5
  • Aside from eToro’s spread, there are no other costs or overheads. Your traders are effectively working for you for free – there are no middlemen involved.
  • The traders’ interests are 100% aligned with your own – they are risking their own money on their trading decisions
  • You can dynamically re-allocate your portfolio of traders at the click of a mouse
  • You can realize profit instantaneously, without the risk of waiting weeks or months, in which time the market may move against you
  • You can open an account with as little as $50
  • You can “cherry pick” the best, most profitable traders
  • You can drop traders who underperform
  • With a massive array of trading styles you can profit in up, down and flat markets
  • By choosing a combination of trading styles, you can customize your portfolio to your exact risks/return requirements
  • Long/short strategies and the high liquidity and efficiency in forex markets means that market timing is not a critical factor in making an investment. This is not the case with most funds and managed accounts

Is It For You?

I understand for many people, trading is both means of making money, as well as a challenge. For these people, they may see copy trading as taking the fun away. For me, I see it as a new and important alternative to managed investments.

With the rise of “social finance”, what we are seeing is the “tables being turned” in the financial world. Banks and other financial institutions are no longer essential conduits to lending, borrowing and the capital markets. And any system which offers investors a better deal has to be a good thing in my opinion.

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About the Author

Steve Connell has spent over 17 years working in the finance sector as a trader/market maker and strategist. Over that time he’s worked for several global banks and hedge funds. Steve has a unique insight into a range of financial markets from foreign exchange, commodities to options and futures.

8 Comments
  1. You make a very compelling case for using etoro over a fund manager – but one of the key advantages I see of a fund manager is keeping your own time free. Surely it’s very time consuming to find the right people to follow, reassess and add or remove the traders who succeed or fail on your terms? At least when working with an investment manager you can get on with other profitable – or fun – activities!

    • I didn’t mean it to come across that way! Actually I was simply highlighting eToro as a cheaper alternative for those who don’t have funds to invest with a traditional asset manager. Given you can invest with a few tens of dollars this is of interest to quite a few people. Yes you are right the time involved can be a problem and should be taken into account.

  2. As long as I see, there are no professional traders on eToro. Risk and reward of social gurus on eToro is insane. My friend is a full time professional trader. When I showed her eToro gurus’ stats, she was speechless. She said “they are not traders but gamblers”. If you’re a trader, you can see how nonsense their trades are. Their risk is way wider than reward. Risk must not exceeds reward. If their risk is larger than reward, that tell us that they are not sure about their trading i.e. they are gambling. You can learn how to trade in the internet. There are tons of source for free.

  3. I think something really important that would be required to succeed in etoro is having a way of scrutinizing the top gurus so that one knows who to really copy for sure. Some top gurus, especially those who are high risk traders make lots of profits which are shortly afterwards followed by huge losses. People should know that high risk trading is for the expert traders with over 10 years of experience in trading. In my opinion, I would rather copy a low risk trader who has good trading records. I may not make much copying him, but at least i would be sure that my account would never get drained overnight! Something else I don’t like about copy trader is that if you copy someone who has huge capital, you will find that a copied trade will always open with a very small amount of dollars. In this case the secret would be copying someone who has a capital close to yours. All the same let me accept that etoro has a very easy trading platform.

    • I used the copy trader for about 1 year. At the end, was down about 40%…that was because I picked only the “star traders” with big gains… if I am honest and now i know more about it, this was a big mistake on my part.

      If you look those with biggest gains like “caraj”, “alyagoot” and “robysms” they are the all going down now or some going nowhere. The wins do not last because they take big risks to get to the top of the rank list. And those who copy them pay the price!

      Remember if they have made a lot of profit then a small loss doesn’t matter much to them. If you just start copying them at that point you see a big fall and have to place trust in them to make the recovery!

  4. As far as learning forex I think etoro is one of the best. As for getting rich, I doubt anyone there is doing that except etoro themselves and maybe a few top gurus. With their copy system and others i’ve tried the problem i always get is the loser traders always lose much more than the winners gain. As the other reviewer mentioned there’s no protection system in place so you are investing naked as it were. They need to fix that and put in stop losses because if a trader goes crazy and blows his account on a few wild trades you won’t have time do anything about it. The guru can add his own funds as well as etoro earnings into the account. This allows him to move stops down and go on trading even when all of his copiers have been wiped out. So the guru’s performance graph you see may not be what you get when copying. The other thing that bothers me are the wide spreads so you have to be up 5 pips or more just to be in profit.

    Etoro don’t let you open an account in a currency other than US dollar which seems crazy. So if your bank account is not in USD they get you again with the deposit and transfer exchange rates. When i’ve done transfers the rate always is about 10% worse than the going market rate. That’s the bad. On the good side i find the etoro social area very addictive. I do log in most days even though i don’t have much money invested there. Reason is i like to get the opinions of a lot of other traders it helps to get a wider viewpoint on what is going on. When Bernanke speaks everyone has one opinion or other.

  5. The amount of really good traders on eToro is quite small. There are lots of people on there both mirror traders and real traders who don’t know what they are doing, so be careful. Read the comments & it is obvious some don’t have a basic clue about finance let alone understand how to trade forex markets. Be careful picking who to copy and always check and scrutinize their progress. Traders can stop trading, move on, die, have a confidence crisis, or whatever. Remember they have NO obligation to stay and look after your money for you. That’s your responsibility. So don’t think mirror trading is just invest and forget!

    You regularly see mirror traders crying that they lost money when they copied someone and didn’t understand what they were doing. Others trying to micro manage the gurus and constantly questioning their trading decisions. Neither is helpful. Some traders have losing streaks and then they start taking bigger and bigger bets to try and recover. If they bet too much capital their account can be blown very quickly.

    There’s no way to see how much per trade is being made, only the trades are shown and not their relative size to the total equity in account. So you don’t know until you start copying someone. This is why it is best to start with a small amount and add more money in over time once the trader proves themselves and you are happy with their trading system and money management.

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