5 Copy-trading Pitfalls
Copy trading has been all the rage lately as more and more inexperienced retail actors enter the trading arena. It is indeed easier for a beginner, or someone of meager means and little time to invest, to simply copy the moves of a successful trader. More often than not though, such an approach fails in terms of profitability, especially if the trader that’s copied is a big, institutional entity.
To be successful at copy-trading, the investor doing the copying should preferably follow someone of his own financial means and goals. Since those successful are usually much better endowed in the skill- as well as the financial department, such a setup remains an impossible one to attain. In fact, most beginners choose to follow and copy celebrity investors such as Warren Buffett, and are then flabbergasted when this strategy fails miserably.
Here’s a countdown of the five most common reasons why copying someone like Warren Buffet won’t make you rich.
1. A Matter of Patience
Most people consider themselves long-term investors, but the truth is that when it comes to patience, they’ve got nothing on institutional actors. Looking to reap rewards after 12 to 24 months of holding a stock is the hallmark of the retail small-timer. Institutions don’t do that. Their horizons are much further out. Think 5-10 years in this regard.
That said, it is clear that even if they were able to achieve proper diversification (which is highly unlikely as well) average retail traders would be quite unable to sit on their investments for that long. Institutions are not faced with problems that may prompt retail investors to tap their investments ahead of time. They don’t have personal emergencies, they don’t need the money for school, for a house or for a family.
This brings us to:
Copying a few moves of an institutional actor doesn’t even begin to scratch the surface of what that institution has going diversity-wise. Indeed, it is not uncommon for such a heavyweight investor to hold more than 100 stocks in its portfolio. Needless to say, such a diversity is impossible to cover for a retail actor.
Unfortunately (for the small guy that is…), extensive diversification is something that most successful traders are very good at, which means that whomever you choose to follow, will likely have his/her/its risks spread in a manner that you will find impossible to mimic. Proper diversification doesn’t just take money, it also requires financial wherewithal that retail traders simply do not possess.
What usually happens in this regard is that the copier ends up mimicking only some of the trades of the copied entity, which is a more or less surefire recipe for disaster.
Couple this problem with the investment horizon one discussed above and you hardly need to learn about the other 3 pitfalls we’re about to cover.
3. Access to Information
Institutional and professional investors can afford to sit around and wait for information that allows them to jump in and out of trades at the right moment. After all, they have dedicated teams of experts keeping their eyes on the markets and on the information flow.
The same thing can obviously not be said about Retail Joe. He’s got to work, to go to the gym and to tend to various issues pertaining to his everyday existence. He will always be a few steps behind the professionals when it comes to making moves, and that will cost him.
Institutional actors have specialized trading platforms at their disposal too, so their advantages over the little guy are compounded in several ways.
4. The Cold, Hard Costs
Institutional traders as well as retail actors who make their living this way, have much more money to invest than a recreational player looking to open up an additional revenue stream. They also trade a lot.
What the above means cost-wise is that these big actors enjoy preferential treatment costs-wise. While it costs them a penny (or often even less) per share to pick up a large block of shares, the small guy will pay 5-10 cents per share for the same privilege.
Apparently, this preferential treatment regarding large investors persists in the field of execution too. Though this is downright illegal, institutions will often see their trades pushed ahead of those of small-timers.
These advantages cannot be matched by retail traders, even if they manage to get all the other variables right, and over time, and with larger volumes, they make a massive difference indeed.
5. Tracking and Company-research
Properly researching a company is – even in this age of unprecedented information-flow – all but impossible for a retail trader. You may argue that this is exactly why blindly copying the moves of an institutional investor makes sense, but you’d be wrong. As the entity you aim to copy buys and sells stocks left and right, you will find yourself overwhelmed with the sheer amount of copying you have to do. Blindly following is never a good idea and we’ve already listed four reasons explaining why that’s the case, above.
Instead of engaging in the most-often-futile exercise of mimicking the trading moves of successful institutions, try to adopt an investment strategy that suits your particular needs and means. That’s a much healthier approach over the long-run.