What to Expect When Copying a Trading Strategy
- By FXT
- October 05, 2023
- FXT Analysis
Trading is an exciting and amazing experience, whether you are trading yourself or copying someone else’s strategy on autopilot. For anyone new to the trading world, this article will dive into concepts of what to expect and the early steps you can take as a trade copying investor.
You’ve probably already convinced yourself to start copying if you are reading, but just in case you’re not fully on board, let’s take a look at some of the reasons to copy trade.
Being a good trader can take experience, study (knowledge) and effort. The ability to tag along and follow someone else’s trading strategy means you can skip all the hard work and use your capital to invest in someone else’s efforts. Just like if an investor were to buy into a company where a person was using their skill and effort to make money, then the investor gets a cut, copy trading works in a very similar fashion.
Effortless and Easy
Trading isn’t necessarily easy, but it can pay off and of course, the money is real. Copy trading takes the effort part of trading and tosses it aside, as you use your capital to back someone else’s efforts.
Once an investor has searched through and found a strategy they like, it’s as easy as pressing ‘copy’ on the account, that’s it!
Copying is simple and doesn’t require effort from the investor to keep it going.
Leverage Skills and Knowledge
You may have heard of a statistic that somewhere between 70% to 90% of trading accounts lose money. To make a little more sense of this figure, it needs to be delved into further. This figure includes accounts from new traders that don’t have experience, new traders that have done training but no live market trading, punters looking to just ‘have a go’, people with experience but poor mentality, financial or other stresses (influencing poor decisions), test accounts testing Expert Advisors and strategies, then finally the professional traders and serious traders that actually make money.
If we put this concept into another industry, such as being a doctor, if the effort, training, experience and knowledge had not been developed, most people would fail the test to go into the profession. When compared to trading, anyone is allowed to jump in and try it for themselves, meanwhile most people are unwilling to put in the required effort, study, training and develop real world experience.
Imagine if you could put money into a doctor or other professional and get a return off their efforts directly. It would be somewhat similar copy trading. By investing in someone who is in the market, earning a profit and has experience (which you can view from the statistics of the account), copy trading allows investors to leverage someone else and earn along the way.
Copy trading is great for just about everyone with spare cash to invest, even traders!
Copying someone else’s strategy can allow you to focus on what you do best, whether that is your job, career or business, while investing in the markets through a strategy.
For traders, it allows for diversification away from their own strategy and market, since trading can encompass a range of ideas and markets.
What are the benefits of trading?
Aside from the obvious desire to increase profits, there are a range of benefits that trading has to offer that are often overlooked. By copy trading, you gain access to additional potential benefits such as the below which may add even more value to the concept of copy trading with FXT.
- Access to liquid cash, fast.
- Depending on the strategy and risk, most of the assets can be held in cash most of the time.
- Access to leverage and effective buying power.
- Taking snippets of market moves, potentially reducing exposure to economic fluctuations
- If the market is moving up or down, there is opportunity long and short
- Low cost and low fees (compared to property and shares)
- Benefit from the law compounding returns each time a profit is made
- Access to software for charting, analysis and risk management
Risk Allocation Settings
Once you’ve found your trading strategy and clicked copy, the default risk allocation method will be applied to existing trades and future trades unless the allocation settings are changed for the account. To better understand the risk allocation methods available, this article provides examples and explanations around each method.
The Default Settings
When you first copy a strategy, the default risk allocation method is (Equity x Ratio), where the Ratio is set to 1. This factors in the equity between the copying and copier accounts, and the manually set ratio (defaulting to 1 at first).
If the copying account equity held by the investor is $10,000 while the strategy provider’s account equity is $100,000, the equity difference is 10,000 divided by 100,000 giving 0.10 or 10 times less than the strategy provider’s equity. Since the default Ratio is set to 1, the volume or lots (interchangeable term) will be 10 times less than the strategy provider’s trade.
So, if the strategy provider’s trade volume is 5, the investor’s copied trade would have a volume of 0.50 or 10 times less volume than the original strategy’s trade.
This method uses the difference in equity between the two accounts to determine the volume to create the position.
Adjusting for the Ratio
Since the ratio defaults to 1, there is no further calculation after working out the equity difference unless the Ratio is changed. Changing the ratio means an additional lever to alter the volume of the investor’s trades. Increasing the ratio will increase the lots traded, while decreasing the ratio will decrease the lots traded.
Using the initial example of 0.1 (or 10 times less than the strategy provider’s lots), lets adjust the Ratio to see what happens to the lots for the copier.
Increasing the Ratio
With a Ratio setting of 2, the equation will double, becoming 0.1 to 0.2 for Equity difference multiplied by Ratio, or (10,000 / 100,000 x 2 = .2), the trade of 5 lots for the strategy becomes 1 lot for the copier. When calculating the lots, the equation is (5 lots multiplied by the equity x ratio result of 0.2 which gives a value of 1, or 20% of the strategy trade’s lots in this case.
The use case for increasing the ratio is for a strategy which has good returns however the risk tolerance is lower on the strategy than the investor is looking for. The investor can then choose to increase the risk they trade by increasing the ratio.
It is important to keep in mind things like maximum drawdown, daily drawdown and margin levels and your own risk tolerance when considering increasing the ratio.
Decreasing The Ratio
Let’s say you, as the investor, wants to decrease the risk to half of what the strategy provider is using. For example, perhaps the strategy provider’s maximum drawdown is 10%, while you are more comfortable with a max drawdown of 5%, so you want to halve the volume traded each trade in your account. The ratio to use in order to halve the risk would be 0.5 (instead of the default of 1), which will halve the risk per trade.
In the original example, the lots were 0.5 without any ratio changes. If we were to set the adjustable Ratio to 0.6 (or 60% of the equity difference), the effective lots traded would now be 0.3 rather than 0.5.
Rounding will be pushed to the nearest lower value of volume for calculations based on the minimum volume step or increment. If the minimum volume increment is 0.01, a calculation for 0.025 would return a volume value of 0.02 (rounding off the 0.005 portion of the calculation).
This is to reduce risk rather than increase it up to 0.03 for example. As the account is larger, the effect on risk percentage is reduced.
Effectively, the default setting is % by equity, which in the original example is 10% or 0.1 from Provider to Copier based on their account values. The concept remains very similar for other methods, only using different values to measure the difference and risk.
The image below shows the Toolbox section where you can find Balance, Equity and Free Margin. Allocation methods use either Balance, Equity or Free Margin to adjust for the variance between strategy provider and copier. As a rough guide, if the strategy provider’s account is bigger, the volume will be reduced for the copier account unless the ratio amplifies the risk higher. If the copier account is bigger, the volume will be larger than the strategy provider’s account, unless the ratio is set lower than 1, which will reducing volume copied.
Where to See Your Balance, Equity or Free Margin in MetaTrader 4 or 5
The image below is what you are looking for in your platform and it is located in the Toolbox or Terminal section of your MT4 or 5 platform. This section is usually towards the bottom of the platform and you can toggle it on or off by pressing “CTRL and T” for Toolbox. Then, ensuring you are logged in to the MT4 or 5 platform, check that you are in the ‘Trade’ tab within the Toolbox section.
Components of the Equation
The equations are made up of two types of information. One is essentially where the information comes from (i.e. will you use balance, equity or free margin), while the other is a ratio that can either increase or decrease the comparative volume for the investor copier account. The reason there is an equation is to normalise the difference between the Strategy Provider account size and the Investor’s copying account size, making the volume or lot size traded standardised and relative to the balance, equity or free margin. Once the lots calculation is normalised, the copier can use the ratio to adjust the preferred level of risk based on their risk tolerance and personal requirements.
Compare Strategy Provider Account with the Investor’s Copier Account using a number to compare the two at the time of working out the lots or volume to trade. This normalises the difference so that the effective risk is the same or very similar.
Secondly, there is the option to use a ratio against each risk allocation method, to further adjust the volume to suit the investor. This is a manually altered figure which the investor uses to adjust risk to suit their needs.
The type of risk allocation method refers to the figure used to compare the Strategy Provider Account against the Investor’s copier account. There is balance, equity and free margin which will be covered in more detail later. The input to the equation changes with the term used, so if you use a Balance based risk allocation method, it will use the Balance figure from your account. The same is true for an Equity based allocation method, using the Equity figure, and also Free Margin based risk allocation methods will use the Free Margin number to calculate risk.
Put another way, since each equation uses one item of account measurement from both the strategy provider account and the investor copier account, the selection (between Balance, Equity or Free Margin) simply means that that figure (Balance, Equity or Free Margin) will be used to calculate the lot size, prior to the Ratio coming into play.
To better understand the effect of each, let’s get some insight into what affects each figure.
What Affects Balance?
Deposits, withdrawals and closed trades.
Balance changes with deposits and withdrawals and closed trades. Trades that hold long term positions may not benefit from scaling up or down while these trades remain open.
What Affects Equity?
Deposits, withdrawals, closed trades, open profit, open loss.
Equity changes with rising and falling open trades. Profit will increase the equity value, inherently increasing the lots traded on additional trades while these trades are still open. Loss will decrease the equity value, inherently decreasing the lots traded on additional trades while these trades are still open.
What Affects Free Margin?
Deposits, withdrawals, closed trades, open profit, open loss, margin used for current trades.
Very similar to Equity, the Free Margin fluctuates with open profit and loss, however it also factors in the margin used to hold trades open, reducing that from the equity figure to give Free Margin, or the margin left to continue placing orders.
The ratio is a figure set by the investor, by which to multiply or reduce the outcome of the equation. The ratio is used to scale up or down the risk for the investor copier account.
This might be used where the investor copies a high quality strategy that perhaps has too much risk for their tolerance, in which case they might use a reduced ratio like 0.3 or 30% of the risk used by the strategy provider.
It could also be used where a strategy provider is trading at very low risk for the returns they are producing, and may have a high strike rate which the investor wants to amplify the results. The investor can use a ratio of say 3, to effectively triple the lots used.
Let’s assume that the volume to allocate without considering the ratio is 1.2, the table below shows the resulting shift from the ratio.
% By Balance * Ratio
Balance is the amount of funds in the account, excluding any open trades profit or loss. This means the equation normalises the 2 compared accounts by using the balance figure.
Something to consider is the adaptations to risk when equity is changing and also free margin is shifting.
For additional trades placed if trades are still open, lot size will remain the same volume based on the balance of each account. This means that if equity moves up or down due to profits and losses, no shift will occur in your volume traded since the balance doesn’t move until a trade is closed or a deposit or withdrawal is made. Some traders may prefer that the lot sizing does respond and adjust for new trades when there is already margin being used on the account or open profits and losses that they would like to factor in.
Another consideration is the free margin will be reducing as more trades are opened, however new trades will not be reducing in volume.
% By Equity * Ratio
Equity factors in the value of open profit or loss, whereas balance only reflects the value of closed positions and funds in the account. This means that equity allocations may be a safer option when it comes to assessing the current amounts based on open trades as well.
As equity rises and falls with the account balance and open trade’s profit and loss, this method will reduce risk if the positions are losing. On the other hand, if positions are profitable and rising, the lot size of additional trades placed will be higher.
% By Free Margin * Ratio
This leads us to the next allocation method. While equity considers open trades profit and loss, the free margin method reduces additional position lot sizing, based on how much margin is being used to hold trades open at present.
Free margin factors in the equity amount, so as to include any open trade profits or losses into the allocation calculation. It also considers the margin being used to hold trades open. Margin is the amount of money used to effectively hold a trade open, leaving free margin as the remainder.
Using Free margin means that volume will reduce as more trades are placed, given that the margin increases, leaving less free margin to play with. In saying this, if the equity is increasing due to profitable trades, further trades may remain the same or higher in volume.
This method could be useful where the strategy may have several trades open at once and you want the risk to effectively reduce for each new position opened, due to the reduced free margin.
Fixed lot simply means that each trade made will be placed at a fixed lot size. If the chosen fixed lot size is 0.01, that will be the lot size of each trade. If it is set to 1.0, that will be the lot size for each trade and so on.
For those looking to keep the same volume size regardless of the symbol being traded or the risk level of the Strategy Provider, this one is for you. While the other risk allocation methods factor in account size difference, offering a fluctuation in risk based on the balance, equity or free margin difference, the Fixed Lot method is simply a fixed lot every trade.