Over the last few years, we have seen the emergence of a new trend which is somewhere between execution-only anddiscretionary management, at least in the eyes of many investors. This new trend is commonly referred to as copy trading or mirror trading. As the term suggests, it is the simple process of copying the transactions of a particular individual or company. However, it becomes a bit more complicated once we begin to dig a little deeper.
Execution only trading
We need to define execution-only trading to compare and contrast the characteristics of different trading methods. In simple terms:-
“Execution only is a trading service that is restricted to only the execution of trades, without the client receiving any advice about the merits or risks of the investments, or their suitability.”
Day traders and short-term traders will be well aware of the limited regulatory protection when it comes to execution-only dealing, where no advice is requested or given. Trading is carried out under the investor's own steam, and nowadays, trade execution tends to be via electronic platforms. Consequently, for most people, there will be no element of communication with a broker.
Mirror trading/copy trading
This type of trade execution has been around for a few years and involves investors releasing their trades into the public domain. In theory, due to their track record and knowledge of particular markets, other investors often copy their trades blindly. Consequently, we have seen the emergence of social trading platforms which, in theory, are neither giving advice nor any degree of discretionary management. However, there are regulatory concerns regarding the two different types of mirror trading:-
Non-portfolio management
When a brokerage contacts a client to inform them that an investor they follow has traded, this is not seen as portfolio management. Some may argue this is "advising" the client that the investor has dealt. However, as the trade is not automatically executed and effectively carried out on anexecution-only basis if the trader follows, there is no regulatory burden.
Portfolio management
This is where the difference between execution-only and discretionary portfolio management is best demonstrated. If an investor gives their broker permission, i.e. a mandate, to carry out automatic trades without additional permissions, this is deemed discretionary. This is where automatic trades, allowing investors to follow other investors, seem to fall between two stools. The broker is not taking any actual decision regarding the individual investment but is carrying out an automatic transaction. Hence, this is classified as a form of discretionary trade execution.
The pros and cons of mirror trading
Whether you are an execution-only trader or one who likes to take advice from their broker, you will have investors you follow regularly. However, looking to mirror the investor's transactions is, for many, a considerable jump.
Pros of mirror trading
Some of the benefits of mirror trading include:-
• Following somebody with a good track record
• Dealing off the back of somebody else's research
• Potential self-fulfilling prophecy
• Can be automated, rather than picking and choosing investments
Cons of mirror trading
Some of the potential issues with mirror trading include:-
• Lead investors often get the best price
• Numerous followers trading at the same time could prompt a share price spike
• As well as buying after the investor, you will also sell after the investor
• If market conditions change, the investor’s track record may be irrelevant
While unlikely to attract the attention of professional execution-only traders, those looking to follow successful investors may benefit from mirror trading. It can create a self-fulfilling prophecy but remember, the investor buys before you and sells before you. If undertaking this strategy, you must follow all of the investor's trades to get their average returns.
Interesting strategy, not for everyone
Whether your preferred trade execution strategy is execution only, advisory or discretionary, you always need to be aware of the pros and cons. Likewise, whether deemed execution only, advisory or discretionary, mirror trading also has specific pros and cons. Somewhat caught between tworegulatory stools, it is vital to be aware of your statutory protection when trading.