How to become your fund manager with eToro’s Copy Trader

Long term investing

Warren Buffet, CEO of Berkshire Hathaway, a holding company, once said, “If you don’t find a way to make money while you sleep, you will work until you die.” No wonder the nonagenarian is one of the wealthiest men in the world.

Nowadays, investing and trading has become relatively easy, especially since the advent of Bitcoin. Bitcoin has democratised finance in buying cryptocurrencies. Thanks to cryptocurrency, exchanges have made buying stocks, commodities, bonds, and forex (foreign exchange) from other exchanges painless. Investing has become accessible to everyone regardless of the standard of living, income and geographic location.

In earlier years, you had to go to a stockbroker to invest your money, and the stockbroker would ask you many questions, among other things, to determine your risk appetite. 

To get a more significant cut out of your money, the broker would try to upsell other financial products you’re not interested in buying.

On the other hand, the stockbroker can determine the “best execution price” if you want to buy a specific stock. The broker will try to obtain the most advantageous price on your behalf. It can take weeks or months before the broker purchases the shares on your behalf, especially in highly illiquid markets (not enough buyers or sellers) or when the market is in a bull run. In the latter case, the broker will try to buy a stock lower than the current market price. However, if the markets are doing and the prices of stocks are increasing, it will be more expensive to buy the same quantity of shares.

The broker will charge you either a fixed fee, a percentage fee or both to execute a trade on your behalf. If you opt to buy stocks outside your geographical location, the broker will charge higher fees, as it will need to go through a foreign broker with access to a particular market from where you’d like to buy that share. The fees charged by brokers to buy shares from a foreign market may eat away a significant portion of your investment.

When one goes through a broker, you own the actual stocks.

Enter Contract for Difference (CFDs)

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As the name implies, a Contract for Difference (CFD) is a contract. The buyer enters into a contract with a CFD provider like eToro, Revolut or Robinhood to speculate the price of an asset class such as stocks, bonds, cryptocurrencies, commodities and forex.

CFDs are financial derivates, as the value depends on another asset’s value. For example, Apple Inc, Google (Alphabet Inc) and Facebook (Meta Inc) have their shares traded on the Nasdaq stock exchange. Yet, CFD providers offer Apple Inc CFDs, Alphabet Inc CFDs, etc.

If the Netflix stock price on Nasdaq is $165, then the Netflix CFD on eToro will also be $165. If the price of Netflix retreats by 10%, the Netflix CFD will also go down by 10%.

Unlike actual stocks, you’re not a part-owner of the company. You’re just betting on the stock price.

Differences between CFDs and a stockbrokers 

There are numerous benefits of going to a CFD provider over going to a stockbroker.

Fees

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Not everyone can be a stockbroker, and it requires specialised education, a lot of paperwork, a costly license and stringent requirements from a financial regulator. Nothing is free, and they’ll charge a fee to cover their costs.

On the flipside, CFD providers like eToro charge relatively lower fees compared to stockbrokers. CFD providers make money by charging what is known as a spread.

CFD providers display two prices, a buy price and a selling price known as the spread. The buying price is slightly higher than the market price, and the selling price is slightly lower than the selling price. The difference between the two prices can be a few cents.

CFDs will profit by charging the difference when someone buys and sells. For example, a Tesla stock may have a market price of $1,030. It will have a bid or the buy price of $1,030.50 and an ask or sell price of €1,029.50.

The bid and ask price will be relative to the market price. If the market price of the Tesla stock in the above example increases from $1,030 (bid – $1,030.50 and ask $1,029.50) to $1,100 the following week, the bid price would now be $1,100.50, and the asking price would now be $1,099.50. 

If you were to buy a Twitter stock at a market price of $45 on a CFD exchange and sell it a second after buying it, the exchange would have made $1 in profit, i.e. the difference between the bid, e.g. $45.50 and the asking price of $44.50. The $1 is the spread.

CFDs are relatively cheaper than stockbrokers. CFD providers make money by charging lower fees to a higher number of customers. 

Minimum investment

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Whether you’re buying a stock or a CFD, technically, there’s no minimum amount that you can invest. However, the difference lies in the number of shares you can buy.

You can only purchase a whole share. In the case of CFD, you can purchase a fraction of the stock. Let’s assume that you have $1,000 to invest, and you’d like to buy Coca-Cola stocks at $65 each. You may buy 15.38 Coca Cola stocks ($1,000 / $65 per Coca-Cola stock). Assuming there aren’t any broker fees for this example, you can only buy 15 actual shares.

If you had another $1,000 to invest and you’d like to buy an Amazon stock with a market price of $3,200. You can’t buy it from a stockbroker as you can only buy a whole share. Since the Amazon stock price exceeds your investing budget, you won’t be able to purchase this stock. You may buy 0.31 of an Amazon CFD ($1,000 / $3,200 per Amazon stock).

Control

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Member stockbrokers have exclusive access to stock exchanges. If a stockbroker doesn’t have access to a particular exchange, he’ll need to get through another broker. 

Stockbrokers buy and sell stocks on behalf of their clients at the “best execution price.”. However, a client can ask a broker to buy and sell stocks at specific prices. If the client decides to change their bid or ask prices, they need to go to the broker. The client is at the mercy of the broker to execute their instructions. There may be delays when the client sends the instructions, and the broker acts upon them. Sometimes it may be too late, and the broker would have executed the order. 

Nowadays, CFD platforms like eToro offer user-friendly websites and mobile apps. The client can execute trades at any time of the week during any time of the day.

Most CFD platforms provide feature-rich tools, like buying at the market price or setting a specific price below the market price, so if the stock’s market price goes lower, the trade gets executed. The latter is known as a limit order.

CFD platforms offer features like stop loss and take profit options. Traders stop loss to protect their investment if the market price goes below a certain level. 

Not every trader uses a stop-loss. If you don’t, use one to help you protect your investment. For example, if you bought a share for $100, and set the stop loss at $80, then if the market price of this share goes below $80, it will automatically sell the share at $80 or the best price on the CFD’s order book, preventing further loss of your money.

The opposite of a stop-loss is a take profit option. A take profit option will automatically sell your CFD if the market price reaches your target profit. For example, if you bought a share for $100, you may decide to sell it whenever the market price reaches $120. 

Stop-losses are obligatory if you decide to buy a specific share; however, taking profits is optional. CFDs allow you to adjust your stop loss and take profit anytime.

Most stockbrokers don’t offer these features to their clients, while not all CFD exchanges offer such features.

Holding period

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The holding period is the difference between when a share is bought and sold. The US Securities Exchange Commission, the market regulator that oversees stock exchanges in America, requires a minimum holding period of two days, previously three days. If the holding period is shorter, the SEC will consider this a trading violation and can be subject to sanctions.

Stocks imply whole or partial ownership of a company, while a CFD is a contract.

The two day holding period doesn’t apply in the case of a CFD. The rationale behind it is that stocks influence the price of CFDs and not vice-versa. 

While two days may seem a short time frame, one must remember that markets are fluid. For example, on the 3rd of February 2022, Meta’s shares (formerly known as Facebook) lost around 25% of their value, from $323 per share to $237 per share the next day. The decline cost the company a $250 billion loss in market value. 

If you’re a Meta stockholder, you may want to get rid of your stock immediately, especially if the price is about to plunge that much in a short period. 

Dividends

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Dividends are cash payments rewards the company’s board of directors recommends giving shareholders from its profits. An excellent financial performance usually implies such rewards. Dividends are optional and given to shareholders depending on the previous period’s performance. 

Dividends are beneficial as they increase the share price since they make it more attractive for non-holders of a company’s shares to buy company shares, increasing the share price for existing shareholders.

Certain companies may refrain from giving out any dividends. Dividends get paid from the company’s bank account. Therefore, the board of directors may prefer investing the same money in the company itself, expecting higher future cashflows from expanding its existing operations or investing in new markets instead of dividends. Such a move will also increase the share price, especially after a strong performance. 

CFD owners of the shares that pay a dividend don’t get a dividend payout. However, CFDs benefit from an increase in the market price as if they were actual shareholders getting a dividend.

Making money

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Traditionally, there is only one way to make money: selling a stock at a higher price than you bought it. For example, if you buy a share at $100 and sell it at $120, you would have made a profit of $20. This method is going long. You’re betting that the price will increase. 

Going long is the go-to option provided by brokers and CFD exchanges. However, CFD providers make it easier for clients to go short. Going short or shorting the market means betting that the stock price will decrease. You can make money by taking a short position. For example, you buy a share at $100, and you expect the price to go down. If the share price goes from $100 to $80, then you would make a profit of $20.

Most stockbrokers don’t offer to short stocks on behalf of their clients since it involves the actual shares. Again not all CFD providers offer shorts either. 

Leverage trading and margin calls

Risk
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Leverage trading involves investing money that isn’t yours. For example, if you have $100 that you’d like to invest, you can leverage it five times, investing up to $500. If the market price increases by $5, you make $25.

If the market goes against your position, you’ll need to pay for the lost amount. Let’s assume that the market price goes from $100 to $95, and you’ll own the exchange for $25 and not $5. If the investment goes beyond a certain amount, a broker may issue what is known as a margin call.

A margin call is when the broker asks you to deposit more money to cover your trades.

Leveraged trading is quite common and more accessible on CFD platforms. It makes it easier for these platforms to make money off their clients. Unfortunately, most platforms don’t offer the option to turn leverage trading off and leverage trading features embedded as part of the features of regular trades. Therefore, it’s easier to make a leveraged trade by mistake.

It’s better not to use leverage trading.

Stockbrokers don’t provide leverage trading to a traditional retail customer, as leverage trading requires a high degree of knowledge and funds to cover losses. Financial laws require stockbrokers and financial advisors to assess whether their clients can take financial decisions and their degree of financial knowledge. Retail clients are therefore automatically excluded from leverage trading. 

Choice

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Traditional stockbrokers offer to invest in stocks within their markets. CFDs have more options and choices than stocks in the investor’s market. CFDs give access to foreign stock exchanges. CFDs. For example, if you live in London, besides buying CFDs on the London Stock Exchange, you may buy CFDs on Nasdaq.

Unlike stockbrokers, CFDs give investors exposure to other asset classes, like cryptocurrencies (e.g. Bitcoin, Ethereum), commodities (e.g. oil, gold), forex (e.g. USD-EUR, GBP-EUR) and exchange-traded funds (ETFs).

Keep in mind that you do not own the asset when purchasing a CFD but a representation of that asset.

Expertise

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Traditional stockbrokers have spent years studying and require special permission from a financial supervision authority to provide financial advice to clients. Stockbrokers may create funds that they can sell to prospective clients. These funds are subject to scrutiny by the same authority and are full of disclosures. 

While past performance isn’t a guarantee of future performance, most funds created by stockbrokers bring modest returns.

Certain funds licensed by financial supervision authorities may offer investment compensation schemes, usually disclosed in a prospectus. The financial regulator usually makes payouts if a “firm stops trading or becomes insolvent.” If the broker doesn’t get it right, you may still lose your money.

On the flip side, if people invest in CFDs, they can get lucky. However, investing in CFDs is riskier than going through a licensed broker. It’s easier for retail clients to lose money.

Going in for investment by yourself or through a broker is your decision. If you prefer playing safe, it’s better to go to a stockbroker. On the other hand, if you have the money you can afford to lose, you should try a small amount.

eToro Copy Trader 

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eToro is a CFD platform – probably one of the most user friendly and provides plenty of asset classes to invest such as stocks, gold, oil, Bitcoin, Ethereum, forex and much more…

One can buy individual assets such as Tesla stock, Bitcoin, wheat, etc. Alternatively, instead of going on your own, you may use eToro’s Copy Trader function. “With eToro’s CopyTrader, you can automatically copy top-performing traders, instantly replicating their trading in your portfolio.”

There are over 600 traders you can copy. You can sort traders by performance, risk score, popularity, number of people copying the trader, etc.

The most challenging choice you’ll face isn’t what you should invest in but which trader you’ll choose. Famous copy traders, most of the time, are experienced ones. However, they can always get it wrong too. 

Unlike traditional funds, eToro gives you the ability to see your trade’s performance. Past performance isn’t a guarantee of future returns. Sometimes your investment can go down for a few days after investing due to unfavourable market conditions. The situation can create tension and heartaches, which can convince you that copy trading was a bad idea and that you should liquidate your investment since it’s safer in your bank.

Keep in mind that you should only invest money you can afford to lose. The best strategy is to invest, copy trade and forget. Ideally, you should keep your investment for at least one year.

Disclaimer

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