DEFINITION of 'Mirror Trading'

Mirror Trading is a forex strategy that allows investors to copy the trades of experienced and successful forex investors. Mirror trading was initially only available to institutional clients but was later made available to retail investors. Its automated nature can help prevent investors from making emotion-based trading decisions. Since its inception in the mid- to late-2000s, mirror trading has inspired other similar strategies, such as copy trading and social trading.

BREAKING DOWN 'Mirror Trading'

Mirror traders use a forex brokerage's trading platform to examine the histories and details of various trading strategies. The trader then chooses an algorithmic trading strategy from the available options based on his or her investment goals, risk tolerance, investment capital and desired currencies. For example, if a trader has a minimal risk tolerance, he or she may choose to mirror a strategy that has a low maximum drawdown. When strategy developers execute their trades, these trades are duplicated in mirror traders' accounts using automated software that operates 24/5 with the intention of replicating similar results. Prominent forex brokers that offer mirror trading include AvaTrade, FXCM and Dukascopy.

Benefits of Mirror Trading

Reduces Emotions: Because mirror trading determines when a trade gets opened, closed or amended, it removes the stress of making trading decisions. This is particularly helpful for new investors who may initially find the forex market overwhelming. Instead of worrying about the market’s day-to-day fluctuations, an investor can simply check the performance of his or her mirror trading account at the end of each week and determine if they want to continue using the strategy.

Verified Results: Forex brokers that offer mirror trading usually examine, test and validate the trading results of strategies they upload to their platform that helps filter out losing trades. For instance, before a new strategy is accepted, a broker may require it to have a 12-month track record of profitability with a specific maximum drawdown limit. When selecting a forex broker that offers mirror trading, investors should ask how a strategy's results have been verified to ensure it has undergone rigorous testing.

Limitations of Mirror Trading

Robustness of Strategies: Some mirror trading strategies may only provide good results under certain market conditions. For example, a strategy may perform well in trending markets but underperform in rangebound markets. Investors should test the results of a strategy in various market environments to ensure its robustness.

Risk Assessment: Although it is straightforward to see if a mirror trading account is generating a profit, it is often more difficult to determine what risks were taken to make that profit. For example, a strategy that has returned 300% over the past 12 months may look great initially, but further analysis of the strategy may reveal that to achieve that result, the investor would have had to endure an 80% drawdown on their capital. (To learn more, see: Interpreting a Strategy Performance Report.)

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