Have you ever had to endure the tedium of listening politely to a loquacious individual at a party brag about the killing he made through investing in stocks or the stunning returns his little-known investment manager generated? If you’ve wondered whether there’s a way to get in on the action, mirror trading or investing may be the answer. But before you plunk down your hard-earned savings into a mirror trading account, you should know this fad has a number of drawbacks that may restrict its appeal to a tiny slice of the investing populace.
What is Mirror Trading?
The concept of mirror trading was first introduced in the foreign exchange market in the early 2000s but it took a few years for the equity market to catch on.
Mirror trading basically means replicating the trades in your account by linking it to another account managed by someone who you believe is a savvy investor. Thus, every time the savvy investor executes a trade in his or her account, it is duplicated or “mirrored” in your account. The choice of whom you want to follow and link your account to depends on the brokerage offering the service. Covestor, perhaps the best-known proponent of mirror investing, has over 150 managers whose portfolios can be studied and mirrored with a Covestor account. Ditto Trade, an online brokerage that commenced operations in the summer of 2012, allows anyone (yes, even the party braggart) to become what it calls a “lead trader.”
Mirror Trading versus Copycat Investing versus Social Trading
While mirror investing is sometimes referred to as “copycat investing,” there are important distinctions between the two. Copycat investing attempts to duplicate the investing ideas of reputed investment managers, without the actual physical link between accounts.
Time lag is another major difference. It could take weeks between the time a money manager acquires or disposes of a stock, and when that information is made public for the copycat investor. With mirror trading, this time lag may be virtually non-existent. That’s because the trade order from the portfolio manager and mirror account orders are grouped together and sent to the exchange as a single batch.
Social trading is another strategy often confused with mirror trading. Consider this strategy akin to a social network or community, like Facebook for traders. Instead of news, photos and status updates, people share investment and trading ideas. People who take part in this strategy don’t necessarily need a lot of investment knowledge since they rely on peers or experts. That means they can learn while they earn returns. Some popular social trading platforms and apps include Spiking, Trading View and eToro.
Mirror Trading Players
Some of the major players in mirror trading are:
Tradency: Tradency claims to have invented the concept of mirror trading in 2005. According to its website, its Mirror Trader platform allows retail clients access to strategies and information that was only available to institutional traders. Through Mirror Trader, the firm’s servers track both buy and sell signals from various strategy developers. Traders and investors can decide which signals they want to mirror in their own accounts. After that, they can evaluate and analyze those signals, and then make trades in their own accounts.
Interactive Brokers: Interactive Brokers offers portfolios that allow investors to co-invest with a portfolio manager. By using this strategy, investors can make trades at the same time as the portfolio manager, and at the same price. The account service is fully monitored by the portfolio manager as well as the firm’s automated systems. Investors aren’t bound to one portfolio and can switch at any time with no fees or penalties.
Interactive Brokers acquired another firm that was rooted in mirror trading in 2015. The acquisition of Covestor was fully completed in 2017. Like Tradency, Covestor claimed to be a pioneer in bringing separately managed accounts (SMAs) online in a transparent marketplace. It billed itself as a forum for discovering exceptional portfolio managers, who collectively covered a complete range of strategies, sectors and risk levels. Covestor enabled its clients to save money through low trading costs and automated software which replicated portfolio managers’ trades in mirror accounts.
TD Ameritrade’s Autotrade: Offered by its thinkorswim subsidiary, Autotrade is an automated trading service offered to subscribers of participating advisory firms. If you sign up for Autotrade, you authorize thinkorswim to execute trades in your thinkorswim account based on the strategy and allocation you have selected from your advisory newsletter. By late 2013, there were 29 investment newsletter providers participating in the Autotrade program.
Pros and Cons of Mirror Trading
Here are some of the points in favor of mirror trading:
- Piggybacking on someone else’s expertise: You do not have to come up with your own investing strategy or style, but can piggyback on a portfolio manager or other investment expert’s investing acumen.
- Low cost: Covestor’s portfolio managers charge between 0.5% and 2% of assets per year. The lower end of the range compares favorably with the average 1.21% average annual expense ratio for mutual funds, according to Morningstar. Autotrade does not charge a separate fee for mirror trading, while Ditto Trade allows its lead traders to keep 100% of fees charged by them.
- Removes emotions: Because this strategy is automated, it cuts out the emotions related to trading. So someone who is usually actively involved in trading or is new to the investment world may benefit from this strategy because it’s a passive approach. Investors can stay updated on their portfolios without having to actively take part.
- Transparency: Firms that permit mirror trading generally have full transparency for the accounts being followed.
Now for the drawbacks:
- Limited performance history: Because of their relatively recent entry into the marketplace, there is limited history available on the performance of portfolio managers and other traders who allow investors to mirror their accounts. The vast majority of performance records start after 2009, when the bull run commenced, so investors have no idea how these presumed experts will fare in a severe bear market.
- Style drift: You may sign up to mirror an expert based on his or her investing strategy and style, but what if the expert changes the strategy — say from long-term value to short-term growth — to one with which you are not comfortable?
- Losing the Midas touch: This goes back to the first point about the limited performance history. If your mirror trading guru loses the Midas touch that you were hoping could be continued indefinitely, you may be saddled with large losses.
- Little value generation: Even if you only pay 1% as a management fee, that’s 1% too much if mirror investing results in little value generation for your account.
- Can they really beat the market? When even the majority of professional investors and mutual fund managers are unable to beat the market on a consistent basis, what are the chances anyone else can? With the plethora of investment choices available, an investor may be better off spending a little time and effort in structuring his or her own portfolio using a combination of exchange-traded funds (ETFs) and blue-chips.
So Should You Even Consider Mirror Trading?
Mirror trading may not be suitable for the majority of investors for the reasons outlined above. But if you are seriously considering hitching your account to cousin Bob’s portfolio, a few precautions may be in order. First, do your research. Make sure Bob really knows about investments and isn’t a wannabe trader who considers himself an expert because he regularly scans the business news and online investment portals.
Second, check performance records. Bob may have a killer investment strategy he wants to try out, but if he doesn’t have the track record to back it up, why should your account be the guinea pig?
Third, limit risk by only allocating a small portion of your total capital to this mirror account. If Bob does turn out to be the next Buffett, you can always increase the funds allocated to the account in a measured manner at a later time. But if Bob blows up the account and you had a sizable amount in it, you may find it difficult to recover from that loss.
Finally, ensure that Bob’s investment philosophy reflects your own — this is mirror trading after all. If your personal investment style is to seek steady rather than spectacular returns in large-cap stocks, while Bob’s approach is to shoot the lights out by speculating on microcap stocks, do you really think Bob ought to be managing your money?
Mirror investing in equities could well be a fad that only appeals to a limited number of investors. One large mirror investing firm, Wealthfront, has already bowed out of the business and, instead, offers investments using index ETFs. Mirror investing does offer transparency and the ability to benefit from someone else’s investment expertise, but given the wide range of investment choices available to investors presently, these advantages may not be enough to offset its risks.
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