How does copy trading work?
Updated: Aug 20, 2018
This is the answer based on the reply I gave to a question of one of my copiers on eToro.
Let’s assume that I have $5000 in my eToro account. When you started copying me with $500 (hereby assuming that you copied open trades), you copied all my postions at a ratio of 1/10. Since I’m currently not fully invested —that is I hold a certain cash position— you also copied that cash position at a ratio of 1/10. That means that a certain portion of your investment in me, currently ($500 - $313 =) $187, is kept in cash and shows as not invested. I refer to the post I made on the 1th of July about how I will move away (again) from holding on to a cash position on eToro, within a period of maximum two months. In other words, very soon all of your money will be invested.
Besides that, I add some amount every month to my portfolio, according to the DCA principle. Let’s say I add $500 to my total original value of $5000, you will be asked to add 1/10 = $50 to your $500. This is entirely up to you to do so or to ignore this. If you choose to add funds, your ratio of ($550 / $5500 = ) 1/10 will remain, and my portfolio will be fully mirrored into yours. If you choose to ignore this, a new ratio of $500 / $5500 = 1/11 will apply to new trades, and new trades only. Current trades (opened under a ratio of 1/10) will remain until closed.
Be aware that if you choose to not add extra funds, the previously opened trades, take up a larger portion of your portfolio than it does in mine. If for example, I hold a position of $1000 in stock A on my total portfolio value of $5000, this has a relative position of 1/5 = 20% in my portfolio. If I add $500 of funds to my portfolio, this same position only represents $1000 on $5500 = 18,18% of my portfolio. Given that you copy me with $500, this trade will show up as $100 in your portfolio. Since you decided to not add extra funds, this trade will still represent 20% of your portfolio, while it will only represent 18,18% in my portfolio after I added funds. As such, I have 81,82% of free cash to invest in other stocks, while you 'only' have 80%. This, in the end, could lead to you not being able to copy all the new trades I am opening. In the most extreme case —that is if I were to be fully invested already, and I would choose to fully invest the new funds— you would not be able to copy 10% of my portfolio.
What I recommend to do is the following. I am a strong proponent of DCA, and as such I recommend adding funds if your budget allows you to. If that would not be possible or you’d prefer not to, I recommend to close your copy position in me, and re-open it. As such, you will be fully copying all of my trades without the risk of not copying certain trades. However, since closing and opening trades will incur fees to eToro, because I’m scheduled to add funds every month, and because I plan on rebalancing my portfolio once every two or three months only (I refer to my previous posts), I wouldn’t bother closing and opening your copy position every month, but rather once every two to three months to ensure that you maintain the same exposure as I do.