by Abby Tsype
In FX trading, there have typically been only two options for managing a portfolio; manage it yourself or let someone else do it. But now there is a third option -social trading.
Social trading means, finding top-notch traders, copying their trades and compounding a great portfolio of FX traders that can generate returns for you.
But how would you start? What type of traders should you follow? Tough questions, right? In this article we will answer those important questions.
Short Term vs Long Term
The first thing one must do before deciding to build a portfolio comprised of FX traders is to recognize the various types traders out there. Though there are countless investment strategies, each successful trader has a unique one which makes him or her shine, brings those extra profits and beats the market. Yet if we were to divide those FX traders into two distinct groups it would be short term vs. long term traders: short term traders usually hold their position for up to 48 hours while long term traders may hold a position for two weeks and sometimes far longer. Presuming that both types of strategy, short and long term, can lead to success (and they can), what are the pros and cons of each?
Short-Term Traders: Pros and Cons
First, the pros: nshort term traders are quite numerous. They tend to be more “mechanical” following strict rules as to how much time they spend in the market and how many pips they want to gain (which can be clearly seen when viewing their trading history). Because they trade in high frequency and execute many trades within a short period of time, you can quickly tell when they’ve lost the “touch” and stop copying them.
And the cons? These kinds of traders are vulnerable to rapid price movements. Market volatility can hit them hard because when markets move quickly it tends to hit their stop losses, even if the trend recovers swiftly thereafter.
Long-term Traders: Pros and Cons
One important “pro” of long term traders is that they are more immune to market volatility, especially if they count on trades that last more than several weeks. Although many rely on technical analysis they also consider long-term fundamentals (e.g. interest rates, growth and employment, among others). This means, perhaps, a more balanced approach and a less volatile return.
And the cons? By the nature of their strategy, it may take a while before you know if a long-term trader was wrong on a trade, while in the meantime you could have followed another trader with better results.
Building Your Portfolio
Down to practice – how would you combine the two styles? First, one should allocate to both short and long term traders, regardless of your particular preference, to ensure each style balances the other. For example, within a portfolio of preferred long term traders, adding in some short term traders can generate stable and consistent returns, even as you wait for your long term trader to produce those returns you’re hoping for. You might consider allocating perhaps 50% of your equity to say 2-3 long term traders and another 20% allocated to 2 short term traders.
And if you prefer a short term strategy? Then it’s better to allocate perhaps 50% of your equity to short term traders (up to 3) and allocate another 20% to a long term trader or two.
What to Avoid
Along with building your portfolio, it’s important to consider what not to do or what to avoid. First, ensure that you choose traders with a balanced risk profile and avoid those with unreasonably steep returns. A trader (like the one below) who has gone from 0-1,000% return is not a balanced trader but a risky trader and that is regardless of trade duration.
It’s also vital that you continuously monitor all your traders, especially the short termers who can sour very quickly. If you see that a trader is losing his or her touch don’t be sentimental – break loose and re-populate your portfolio with a new short term trader. And finally, don’t copy too many traders as it will be more difficult to effectively track each. Settle for less, when necessary, as it’s important you maintain control and have the ability to follow and analyze your portfolio of traders.
So, what did we learn here? That no one style (short term or long term) is preferable over the other and that it’s a good idea to have a mix of both, and that monitoring your traders is a key component to success. With those principles in mind, you are ready to go.
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