Managing Copy Trading Risks With Diversification & Gamification Strategies

Copy trading has emerged as one of the most popular features on many crypto asset trading platforms, as it enables novice traders to learn from their more experienced counterparts and start making profitable traders faster. 

When you copy another trader, the performance of your crypto portfolio essentially mirrors that of the professional you are copying. The idea is that you do your research to identify a trader who consistently makes profitable trades, and then you essentially go “all-in” and follow their every move, paying a small fee for the privilege of being able to do so. 

Many experts say copy trading is a powerful way to diversify your portfolio and learn about the various trading strategies employed by more experienced traders. But copy trading doesn’t come without risk. For one thing, it exposes the copier to the emotions and biases of an individual trader. They’re effectively putting their trust into someone else entirely, and there’s no guarantee that a trader who was profitable in the past will continue to be so. 

To make the most out of copy trading, it’s necessary to implement a risk management strategy. The idea is to safeguard your trades against the unexpected market fluctuations that occur in crypto. There’s no foolproof way to eliminate all of the risks in copy trading, but it’s certainly possible to minimize them.

Diversification

Rather than putting all of your eggs in one basket with a single trader, it’s better to try and identify three or four consistently profitable traders and follow each one. By doing this, you’ll be copying from multiple trading strategy providers, which means you can learn more about how each one works. This is diversification in copy trading, and it can help spread the risk associated with the different assets, trading strategies and styles employed by traders.

Risk Tolerance 

Copy traders may also want to specify for themselves what conditions they’ll liquidate their trading position, regardless of what the person they’re copying does. 

For instance, it’s possible when copy trading to establish your own stop/loss ratio, so that any trade you’re engaged in will automatically be liquidated if the asset prices involved vary beyond whatever limit you’re willing to tolerate. 

It might be that one of the traders you’re following has a risk tolerance of up to 10%. But if you don’t want to take that kind of risk, you can set your stop/loss ratio differently, so you never engage in the riskier trades they make. If you’re only willing to risk 3%, for example, you should set your stop/loss ratio at this level. So if you follow a trade and your position depreciates below 3%, the trade will automatically close and cut your losses, regardless of if the original investor wants to hold on until the market swings back to profitability. 

Besides adjusting your stop/loss tolerance, you can also alter your take profit ratio. So instead of only taking profits once the asset you hold is up 10% on the original asset, you could take a profit at just 4%, or 5%, or whatever number you’d prefer. This can help to ensure that you always gain a small profit at times when the trader you’re following gets greedy and holds out for a 10% profit.

Gamified Copy Trading

An alternative to blindly following the actions of emotional traders is to instead partake in a more gamified version of copy trading. 

An upcoming crypto trading platform called Mosaic Alpha is introducing a novel, gamified version of crypto trading called “token baskets”, which puts more of an onus on professional traders to succeed. 

One of the unspoken dangers of copy trading is the razor thin margins involved in many trades. Because copiers have to pay fees on every trade copied, it means they could end up losing money if the trader’s profit margins are too thin. The individual trader who is making the calls won’t care that much, because he also receives the additional fees paid by his followers whenever they copy their trades. For them, it’s really just a second passive income stream, meaning they’re under less pressure to make the right calls every time. 

With its token baskets, Mosaic does away with this risk. It’s really just an alternative take on the copy trading idea, where successful and profitable traders can create a basket of assets that’s managed as a single asset. Within each basket is a pool of crypto assets that can be changed at any time, based on the creator’s whims. 

Investing in a token basket is more akin to following a traditional index fund. The main difference is that, for the investors who create the token baskets, their income is not guaranteed. Instead, they’ll only be able to collect fees from others who invest in the basket if it actually generates those users a decent profit. If the value of the token basket doesn’t appreciate, they don’t earn any official fees. 

This kind of incentivized copy trading experience puts greater pressure on traders to perform consistently, while investors run less of a risk, as they won’t have to pay any fees if the basket under-performs.

Although it’s not yet battle-tested, Mosaic’s enhanced copy trading baskets have attracted some solid support from the Polkadot blockchain community. In August, Mosaic successfully won the 73rd Polkadot parachain auction to become a fully-fledged member of its ecosystem.

Copy Trading Done Right

Besides these risk management strategies, copy traders should always (and often!) take the time to review the performance of their copy trading settings and identify work out which are more profitable. It’s a bad idea to follow traders simply because they’ve been profitable in the past. Understand that previous success is no guarantee of future profit. 

At the same time, copiers are urged to try and understand the intricacies of each trader and the strategy they pursue. The knowledge gained from this may one day help them to design more effective trading strategies of their own. This will require staying informed about the financial markets, learning the ins and outs of different strategies, as well as the market forces that influence asset prices. 

A lot of people have made decent money from copy trading, and while it’s okay to experiment and place some trust in other traders who have more experience than you, just remember that you should always stay in control regarding just how far you’re prepared to go.