What Is Mirror Trading?
Mirror trading is a methodology of trade selection used primarily in forex markets. It is a strategy that allows investors to copy the trades of experienced and successful forex investors and implement the same trades, in almost real time, in their own accounts. Mirror trading was initially only available to institutional clients but has since been made available to retail investors through various means. Since its inception in the mid- to late-2000s, mirror trading has inspired other similar strategies, such as copy trading and social trading.
- Mirror trading allows traders or investors to mimic others by implementing the same trades that others do in the trader's own account.
- Mirror trading can be done in both forex and stock markets, though it is much more common in forex trading.
- Mirror trading has become a more acceptable alternative for traders and investors to consider as information and transparency tools have increased in quality.
Understanding Mirror Trading
Its automated nature can help prevent investors from making emotion-based trading decisions. Mirror traders in the forex markets will often use a brokerage's trading platform (software similar to MetaTrader version 4 or 5) to examine the histories and details of various trading strategies. In the stock market, they may use broker services such as Interactive Broker's Interactive Advisors or a third party site such as collective2.com for example.
After researching performance characteristics, the trader then chooses an algorithmic trading strategy from the available options based on their investment goals, risk tolerance, investment capital, and desired assets to invest in. For example, if a trader has a minimal risk tolerance, they 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 their 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.
Fraud in Mirror Trading
In 2017, Deutsche Bank was fined $425 million by the New York Department of Financial Services and £163 million by the Financial Conduct Authority (British regulators) for trades that were referred to as "mirror trades." However, this reference is not referring to retail traders following more experienced traders, but rather to a way to launder money. Russian stocks were being bought through Deutsche Bank in Moscow (with rubles), and the same stocks were being sold to Deutsche Bank in London (for US dollars). This effectively created a money laundering pipeline that went on for several years. This fraudulent activity should not be confused with legitimate mirror trading despite the misnomer in financial reporting.