Copy Trading Risk Strategies: How to Protect Your Investment

Risk management strategies are crucial in every type of trading.

A good risk aversion strategy will protect you from unforeseen losses and help you profit from risky trades.

With risk management, traders can enter highly fluctuating markets while safeguarding their capital and gaining experience and earnings.

It is crucial to note that risk management can be performed for any asset class in any trading strategy. 

Some strategies are riskier than others and may require a robust risk management plan.

One such strategy is copy trading, in which young or upcoming traders copy the trades of an experienced trader to gain experience and profits.

This means that the trader potentially leaves the fate of their capital in the hands of the trader they are copying.

Copy trading is mainly done through online platforms, and generally, the trader being copied may not know who is copying their trading strategy bit by bit.

This strategy might be profitable, but it is also an excellent way to learn and understand the dynamics of a trading market. 

Therefore, it is crucial to implement a suitable and well-planned risk management strategy in copy trading.

This is because a trader should not depend 100% on the capabilities of the other trader. For personal or professional reasons, what if the experienced trader decides to take a hit in the market or plans a risky play in the market?

There are various reasons why a trader conducting copy trading should consistently enforce risk management techniques. 

Traders can use a few versatile, easy-to-implement risk mitigation techniques to safeguard their trades and capital.

An important thing to remember is that if trades are being conducted in a highly volatile market, it is wise to adjust your risk management techniques accordingly.

This article will cover everything you need about copy trading risk management strategies. 

Understand What is Copy Trading?

Mirroring trades, or copy trading, is an investment strategy in which a trader copies or mirrors the trades of another, more experienced and acclaimed trader.

This strategy appeals to newcomers and beginner investors who want to get exposure to the market and play it safe to minimise losses.

This technique allows them to gain valuable insights into how seasoned investors trade and leverage the market to their benefit. 

As more retail investors enter the markets, copy trading strategies are rising in the forex and stock markets.

This is because traditional self-directed trading is time-consuming and carries a higher risk of losses for new traders and investors.

In contrast, stock or forex copy trading requires minimal effort from the trader, making it easier and more time-efficient for beginners than traditional investing. 

Furthermore, copy trading platforms offer useful metrics, insights, and tools that enable traders to align their investment goals and risk tolerance with experienced and successful traders.

This investment strategy, therefore, offers a unique automated approach to traditional independent investing and exclusively managed funds, ultimately providing traders with control and transparency. 

The Importance of Risk Management in Copy Trading

Copy trading is a risky strategy to deploy in trading.

Your capital will work on the instructions of another trader and their sentiments.

Regardless of the trader’s experience, it is wise to have risk management techniques in place and ready to use when needed.

Here are a few reasons why risk management is so crucial in copy trading:

Market Fluctuations

Sudden changes in markets, such as foreign exchange (forex) or futures markets, cannot be anticipated and can result in significant losses.

Mirroring traders in such volatile markets can expose beginner traders to additional risk, especially when the whole copy trading process is left to automation.

Therefore, it is recommended that the traders diversify their portfolios by mirroring multiple traders who work in various asset classes to minimise the risk of loss due to sudden market shocks. 

Poor Trader Selections

Selecting a trader to mirror is one of the biggest challenges in copy trading. The effectiveness of your mirrored trade will depend on that trader’s experience in the field, trading strategy, risk tolerance, and past performance.

There is no guarantee that all trades started by an experienced trader will be profitable, and there is no guarantee that trades started by less experienced traders will result in a loss.

Therefore, it is very important that when you select a trader and start copy trading, you start with less capital and do not blindly follow an experienced trader’s path. 

High Leverage

Most copy trading platforms allow high leverage, increasing the stakes so that even small market fluctuations can result in significant financial changes, either profit or loss.

To manage the risk associated with leverage, new investors should follow the example of traders who adjust the capital allocated to higher-leverage trades or implement conservative leverage strategies, ultimately mitigating leverage risks.

Key Risk Management Strategies for Copy Trading

Here, we explain some key risk management strategies for copy trading and other methods. 

2% Rule

The 2% rule is more of a principle than a strategy. This rule states that a trader should never risk more than 2% of their whole trading account capital on a single trade in the market. Many traders live by this rule, and others think it’s too low of a percentage.

The 2% rule is a good way to start trading and ensure you do not trade with a risky amount of capital at once. 

3-5-7 Rule

The 3-5-7 rule is a strategy that dictates your risk exposure based on your confidence in the trade. According to the rule, you should risk around 3% on a standard setup, around 5% on a high-probability setup, and around 7% on a highly confident trade.

Copy traders can adjust the percentage of this rule by changing their risk exposure to trade confidence ratios. The main thing here is to show consistency and stick to the strategy. 

Stop-Loss Orders

A stop-loss order is one of the most effective and widely used risk management techniques. In this technique, orders are placed in advance with the command to sell the position if the price of an asset falls below a certain level.

This versatile technique can be used in various ways to minimise losses. 

Diversification

Mirroring various traders instead of one can significantly decrease the risk of loss.

Different traders use different insights and trading strategies across various assets and asset classes.

This way, you can avoid being significantly impacted by market downturns and guarantee stable returns over time. 

Adjusting Strategies Based on Market Conditions

Most of the time, copy traders leave their portfolios on full automation and only check back occasionally.

However, it is best to adjust your strategies based on market conditions and traders to maximise your returns. 

Copy Trading Risks: 3 Hidden Dangers Every Investor Must Know

The following are three dangers of copy trading every investor must know:

Reliance On a Single “Star Trader” 

When starting in copy trading, most traders rely on the expertise of a single trader.

This is not recommended, as the best approach is to follow several traders and find the one whose strategy best matches their goals.

Additionally, it is best to follow traders who trade in different asset classes so your capital can experience the broader market and profit. 

Platform Downtime

Most copy trading is done through online platforms that use servers. During high market volatility or when many trades are being processed, the platform may experience some unexpected downtime.

This means that you might not have access to your account and trades during this period. Regardless of how the market develops, your trades will also follow suit.

To avoid such conditions, the best bet is to choose a highly reliable platform and enforce risk mitigation techniques that work even when you cannot access your account. 

Sudden Market Events

No one can anticipate sudden market events. They can be profitable but also cause a loss in a short amount of time. This is why risk mitigation techniques are crucial.

Everyone knows that an asset might experience fluctuations if big industry news is coming out or a policy change is expected.

However, for world economic news and turmoil that cannot be predicted, placing stop-loss orders and position sizing is key to minimising loss. 

How to Evaluate and Select Traders to Copy

The most essential thing while copy trading is to copy a trader who will bring you profit and experience.

Finding traders that work well with your financial goals can be tricky and largely depends on your goals.

Here are a few metrics to evaluate and select traders to copy. 

Past Performance

This is one of the most important metrics of all time.

A trader is known for the trades they performed in the past, including the positions they took, how long they held them, their entry and exit strategies, risk mitigation techniques, and more.

Before copying a trader, try to understand their past performance. This will help set expectations from the trades and give you an idea of how their trading mind works.

The more experienced the trader, the more you will learn from them. 

Drawdown History 

Evaluating the drawdown history of a trader’s trades can reveal a lot about their strategy and trading mindset.

It will help you understand how the trader views loss and their strategy around it. 

Risk Profile

Finally, evaluate the trader’s risk profile. This will show how reckless or not the trader is and what that will mean for your capital.

The risk profile of each trader speaks volumes about their trading strategy and can indicate whether this trader is a good match for your trading goals. 

In addition to these three metrics, a trader can be judged on the floor based on his character and conduct.

Word-of-mouth is also an excellent metric for judging the competency of a trader you wish to copy.

However, you will fully understand the game once you’ve invested capital and can then make decisions that work best for you. 

Legal and Regulatory Considerations in Copy Trading

Copy trading is perfectly legal in most countries and is conducted online. These platforms have an obligation to maintain order and accountability for all their users.

These platforms must obtain a license from the relevant authorities to conduct online trading.

It is now up to the traders to decide which platform they will use and give their personal information and capital. 

In conclusion, copy trading is an investment strategy in which a trader copies or mirrors the trades of another, more experienced and acclaimed trader.

This strategy appeals to newcomers and beginner investors who want to get exposure to the market and play it safe to minimise losses.

However, complete dependence on another trader is not recommended. So, several risk management techniques should be implemented to protect your capital and profit. 

These techniques include position sizing, following the 2% and 3-5-7% rules, putting stop-loss orders, and diversifying the portfolio.

Another critical thing to remember is that following only one trader is a mistake.

The best strategy here is to follow a couple of different traders and see which one best suits your strategy.

Also, remember to find traders who trade various asset classes, as this will give you a more diverse learning experience. 

We want to emphasise while copy trading might be attractive to many traders, it is also risky.

Before jumping into copy trading, we suggest trying a demo account. This will help you understand the market more deeply and assist you in making financial decisions without using real capital. 

FAQs

Is Copy Trading Legal?

In most countries, copy trading is entirely legal and mainly conducted online. Fees are specific to each platform.

It is most popular among beginner traders seeking to gain market experience and passive income traders seeking to make a profit. 

Are There Any Limits on Copy Trading?

There are no minimum or maximum limits on copy trading, so each trader can trade as much capital as they want.

However, we encourage traders always to enforce position sizing and the 2% rule, where possible, to minimise losses. 

Does Pu Prime Allow Copy Trading?

Yes, Pu Prime allows copy trading and is one of the most user-friendly platforms for this type of trading.

You will need to register an account. After which, you can deposit your capital and copy trades with ease.