What is Social Trading?
Social trading is a new phenomenon that embeds traditional online trading within a social network platform, such as Facebook or Twitter. The result is a trading marketplace, which is known as a Social Trading Platform (STP), where traders can come together to discuss strategies, follow, and even copy each other’s trades in real time. The increasing popularity of social trading can be attributed to two key characteristics:
- High level of transparency where traders’ activities (trades, discussions, etc…) are published on their personal profile pages. This is a great advantage to retail investors who are often disadvantaged by the secretive nature of traditional investment funds (such as mutual and hedge funds).
- Collaboration among traders to build better trading systems and achieve superior aggregate returns, which is opposite to the behavior of traders in exchanges whose primary objective is to keep their strategies secret.
Types of Social Traders
Traders on STPs can be divided into two main groups:
- Gurus (a.k.a. trade leaders or signal providers) are experienced traders with a proven track record that is displayed on their profile page. Gurus conduct their own financial analysis, which can be based on technical, fundamental, or a mix of both types of indicators and information. Based on their analysis, they build and test a trading system in order to check its profitability, and once they find the optimal strategy, they implement it using their personal equity.
- Investors (a.k.a. trade followers or signal followers) are typically beginner traders, or investors who don’t have enough time to conduct their own due diligence and analysis, but want to invest their money and gain exposure to a certain type of trading strategy. In order to do so, they can set up their account to automatically mimic the trading activity of Guru traders through a feature called mirror trading. Moreover, they can choose to copy only specific trades instead of copying the entire portfolio of the Guru. While investors may lack the time or technical skills to build profitable trading systems, they should however conduct some due diligence on the Guru they wish to copy. After all, investors are entrusting Gurus with managing their investment, thus they should make sure that the Guru has the potential to manage their money in a manner that suits their personal investment preferences. It is important to note that investors can still dedicate a portion of their money to conduct their own analysis and carry out their own trades.
What is Mirror Trading?
Mirror trading allows investors to set up their brokerage account to mimic that of another trader. In particular, any trade executed by the Guru will be instantaneously replicated in the account of the investor at a price identical to that obtained by the Guru. Moreover, any future actions by the Guru related to that trade (such as stop-loss, take profit, etc…) will also be automatically executed in the investor’s account. The mirror algorithm is usually applied in one of two ways:
- Investors can copy the entire portfolio of the Guru, meaning that all current and future trades in the Guru’s portfolio will automatically be copied into the investor’s account. This relationship will cease to exist only when the investor decides to terminate it.
- Investors can copy single trades executed by the Guru, which happens when investors decide that a specific trade is likely to be profitable and that they would like to have exposure to it.
STPs as a New Source of Information
One important outcome of STPs results from trader interactions on the platform. This social information can take several forms.
- A basic interaction among traders is clicking the “like” button on another trader’s strategy to show support for that strategy.
- Following a specific trader in order to obtain live updates on all future activities of that trader means that this particular trader usually provides valuable market insight and is worth keeping in my network.
- Traders can comment on each others’ trades to give their feedback, propose alternative trading strategies, or talk about their experience with that strategy.
- Traders can copy each others’ trades, indicating that the copied strategy is believed to be profitable by other traders as well to the point where investors actually invest in that strategy.
Given the above list of social information investors can now conduct their own socio-financial analysis in order to identify which Gurus have the most optimal trading strategies and risk-management systems, as well as which Gurus trade in a manner that most suits the investment goals and risk profile of the investor.
Why Join an STP?
For the Guru, the main benefit they receive from sharing their trading strategies with the social trading network is a monetary compensation. The way this compensation is calculated varies from one STP to another; however, STPs usually offer one of the following three main schemes:
- Based on the number of trades executed (regardless of whether or not these trades were profitable).
- Based on the number of follower the Guru has.
- As a percentage of profits generated in the followers’ accounts related to copied trades.
Another benefit enjoyed by Gurus is that STPs allow them to create and showcase their track record in front of thousands of investors. This helps Gurus build a reputation which will attract more followers resulting in a larger compensation payoff.
The benefits for the investors for joining an STP are also numerous; however I will only name two.
- First, STPs enable investors who do not have the time or skills to trade, to still invest their money and have it managed by more experienced traders.
- Second, beginner traders can learn the art of trading directly from the Gurus, by following their strategies, and having their money managed at the same time.
Can You Get Rich With Social Trading?
Skilled Gurus with an attractive track record can indeed increase their compensation as the number of their followers grows. Hence, the key here is to have a strategy that generates consistent returns with minimal drawdown in order to have a long and profitable track record. The better your track record is, the more investors will follow you, and the higher your compensation will be.
As for investors, the main point to understand is that this is NOT a get-rich-quick scheme. Any Guru who promises that their strategy will make you a millionaire by the end of the year is simply after the compensation he will get from trading your money. Nonetheless, it is possible for investors to follow Gurus with consistent and low-risk strategies who generate returns that beat the market.