Apr 21, 2021
There are a number of strategies you can adopt when trading. Which one you choose depends on your goal. For those of you who are new to day trading and are in the midst of researching your approach, you might have come across the term ‘mirror trading’. Let’s take a closer look at what that entails.
What is Mirror Trading?
Mirror trading was first introduced in the early 2000s and is now offered by numerous brokers. It was primarily used in the foreign exchange market and found its way to the equity market a few years later. At first, it was only available to institutional clients. Now it’s used by retail investors, too.
When it comes to forex markets, mirror traders will typically use a tool offered on a broker’s platform to identify which strategy to follow. In the stock market, the same traders are likely to use a broker service or third-party site.
As a strategy, it uses an algorithm that allows you to mimic the trades of successful, seasoned traders. After examining the performance of other traders, you can choose which one best suits your personal situation. By that, we mean your risk tolerance, selected investment assets, and investment capital. Once you’ve made your decision, your account and the professional investor’s account are linked.
The same trades are executed in your own account in close to real-time. The virtually non-existent time lag is an important distinction in mirror trading. Once the trade is made, the mirroring account will automatically take the same action. If it weren’t automated, it could take weeks for the information to be sourced and duplicated. At that point, the trade might be less lucrative.
How Does it Differ from Standard Automated Trading?
Mirror trading differs from automated trading in that you are mimicking the trades of an experienced investor. Automated trading lets you set out your own trading parameters and then automatically execute deals based on your criteria. Therefore, the decisions are made by you, including when to enter and exit the market. When it comes to mirror trading, the primary trader you choose to follow is the core decisionmaker. So, a lot of the legwork is done for you.
Pros of Mirror Trading
- Removes feelings from the equation
Mirror trading can be a beneficial strategy for beginners and those who take a very active approach to trading. This is because it is a passive approach, so there is no room for you to make trading decisions based on emotions. You can stay updated on your portfolio without having to actively participate in trades.
- Gaining from someone else’s knowledge
You do not have to create your investing approach. Instead, you can gain from those who have years of knowledge. That means you are operating like a seasoned player rather than someone who has just entered the game.
- Transparency & Testing
Brokers that allow mirror trading operate a full transparency approach. That means that important financial information is available to you. The more information you have access to, the easier it is to make your decision.
Usually, brokers that offer mirror trading will test the different strategies themselves so that they can filter out losing trades. An example of this is if a broker requires a one-year track record of profitability with a specified maximum drawdown limit from a trader before allowing them to partake in mirroring.
Cons of Mirror Trading
- Relying on someone else’s success
With mirror trading, you are solely relying on the expertise of another person. There is always the possibility of the trader losing their touch or simply making an error in judgment, no matter how experienced they are. That could lead to losses.
- Unexpected strategy changes
When you begin to mirror another trader, you match up your criteria with their strategy. However, over time, the trader could change their strategy to the point where it no longer matches your needs.
- Is the market beatable?
If you consider the fact that professional investors and mutual fund managers cannot consistently beat the market, it begs the question: can anyone? It might be a sign that, instead, it’s wiser to include a variety of securities in your portfolio, like ETFs (exchange-traded funds) and blue-chip stocks.
A Few Things to Consider When Choosing who to Mirror
- Are your objectives aligned?
Consider whether you are on the same page as the trader you are choosing to mirror.
- Do you have the capital?
Ensure you have the funds needed to execute the trades.
- Have you done your due diligence?
Do as much research as possible before choosing to mirror someone’s activity so that your decision is well-informed.
To Sum Up
There is merit to mirror trading as you can trade like an expert even if you are not well-versed in investing. However, as with most things, it has its drawbacks, too. You need to do a great deal of research before deciding to follow someone else’s strategy. To get the most out of your trading, you should carefully consider your goals and ensure you are always working to meet them.