Pros and Cons of Mirror Trading for Retail Traders

By Louis H-P on October 17, 2021

Mirror trading for retail traders has become appealing to the new generation of do-it-yourself investors. A strategy which allows uninformed new traders to make money with reduced stress has its appeal. Although the pros are attractive what are the negatives of this strategy?

What is mirror trading for retail traders?

Mirror trading is a form of copy trading, where you are copying another strategy. Whereas copy trading is focused on copying human induced trades, mirror trading is focused on copying automated trading strategies. This means algorithmic strategies.

Algorithmic strategies work according to specific rules. The software program will only trade when certain conditions are met. This takes the emotion out of trading. The human element is not taken out completely. You still need a human to write and create the rules for the software.

These strategies can be applied for both stocks and Forex, but more common with Forex strategies. Originally they were designed and used by institutional traders but mirror trading for retail traders has become more common. As there are different strategies, traders can choose which best suits their risk tolerance.

The benefits of mirror trading

You can outsource your wealth creation

In a world where commuting, longer hours for lower pay is the norm, it is harder to have time for personal finance. Mirror trading allows you to choose a strategy which works for you and requires little additional work once set. It would wise to keep an eye on it though.

Some of these strategies have been running for several years. This gives you a good chance to look at how they coped with sometimes abnormal volatility we have had in recent years before investing your money. In turn you get back to living your life whilst growing your wealth.

Let the fast-learning expert do it

The internet has brought down many barriers to areas of life once reserved for a select few. Investing in public markets is one of them. The problem is they evolve, so the knowledge you acquire today may be useless tomorrow. You also may not have the time and inclination to keep updating yourself.

A strategy which targets working from home, renewable energy, sustainable investing is likely over the medium to long-term to be worthwhile. You will know that, but may not know which companies are at the forefront of the thematic investing trend. Let the computer do it for you.

Takes away human emotions

Markets are a pricing mechanism. The value of a security is set by its ability to create profit and above all cash. Throw in earnings upgrades, i.e. the ability to grow these profits and the equation becomes muddyer.

Throw in human emotion and you get real problems, especially with the type of Robin Hood investor who does little or no research. They just buy because they ‘believe in the what the company are doing’ (Tesla anyone?). Valuation does not come into it.

An automated trading software with a clear set of disciplined rules will make less mistakes and will not get emotionally attached to hot stocks or overvalued stocks.

The negatives of mirror trading

Algorithmic strategy could go haywire

In 2012, Knight Capital, a market maker lost $440 million in 45 minutes after an algorithmic strategy went berserk. Knight capital had launched a new strategy but there was a mistake in it: it was buying securities at the wrong price.

Due to the speed at which these strategies operate, Knight Capital employees could not identify the problem quickly. As a result, other algorithmic strategies swooped in and made a killing at the expense of Knight Capital.

It increases systematic risk

Systematic risk is where a combination of factors cause the entire investment world to panic and sell. Without confidence, there is no back-stop to stop the selling. Even when industry leaders, such as the House of Morgan in 1929 stepped in to stop the 1929 crash, they cannot.

in 2010, market participants where shocked to see US markets lose trillion dollars of value in the space of just over 30mins before bouncing back again. Although never conclusively proven, what has been named the Flash crash, is believed to have developed due to algorithmic trading programs worsening the selling (and subsequent rebound).

You are still loosing out…

It may sound a little peculiar to hear this but you are still likely to lose out. You are likely to be invested in a run-of-the-mill algorithmic trading software. It is not as sophisticated as others. Some institutional traders run algo-sniffing strategies which prey on this mis-match.

This is where vastly powerful computers work out what the slower computers are about to do and trade against them. Think Terminator 2, where Arnold Schwarzenegger’s Terminator has to compete against a vastly superior T-1000. Although you may not be at risk of death, you are likely to lose out financially!

Conclusion

Mirror trading is not for everyone. Many of these sophisticated strategies will be too risky for many run-of-mill investors. Also they do what passive investment can do just as well with much less risk.

On the other hand, there are high-risk investors who are comfortable with the risk and the possibility of earning a superior return. The question you will need to work out, is which one are you?

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Louis H-P

Louis is a portfolio manager and a trader who brings a wealth of experience in private banking to The Lazy Trader. A fundamentalist and a trouble-shooter, Louis makes a firm contribution to the trading team.

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