Copy trading
With copy trading, you automatically take on other users' positions. The displayed leaderboards are skewed by selection, and the copied traders' incentives don't match yours.
The idea sounds sensible: instead of trading yourself, you copy someone who can. The platform shows you leaderboards with impressive results.
The first problem is selection. Among ten thousand users, some will have several very good years by chance alone. Those are exactly the ones at the top of the list. Their visibility comes from the outcome, not from skill.
The second problem is incentives. Anyone paid by number of copiers has a reason to produce eye-catching results. High risk leads either to a top spot or to vanishing from the list, and only the first case is visible.
The third problem is execution. When thousands enter the same position at once, you get a worse price than the trader you're copying. So you pay more for the same idea than they do.
Leaderboards are subject to selection and survivorship bias. With a large number of participants, it follows purely from the distribution that some will show strikingly positive results over several years. Without knowing the total population and the participants who dropped out, a top spot isn't interpretable.
The incentive structure favors asymmetric risk. Compensation based on copied volume is economically equivalent to an option: the copied trader shares in the upside but doesn't bear the copiers' losses. Optimal behavior under this structure means taking on more risk, which matches the observed patterns.
On top of that, simultaneous replication worsens execution. With limited market depth, the bundled volume moves the price against the copiers executing later. The effect grows with the copied trader's popularity, which is why copiers' results systematically lag behind the trader they're copying.
Summary
- Top spots also arise from chance with a large number of participants.
- Compensation by copied volume one-sidedly rewards high risk.
- Simultaneous execution worsens your price relative to the trader you're copying.
Did you get it?
Why are leaderboards skewed?
Because with many participants, some perform strikingly well by chance alone, and those who dropped out aren't visible.
What incentive does compensation by copied volume create?
More risk-taking, since the copied trader shares in the success but doesn't bear the copiers' losses.
Why do copiers' results typically lag?
Because bundled simultaneous execution shifts the price against them.
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