Definition of social trading
What is Social Trading?
Social trading is a practice by which Traders can copy trades made by other Traders. In social trading, a trader's investment decisions are therefore based entirely (or partially) on the investment decisions of other traders. Social trading is a kind of "socialization" of online trading.
Social trading originated with "web 2.0", which gave birth to the social web; internet users now have at their disposal new interfaces that are easy to use and require very little technical knowledge; through these interfaces, users can interact, exchange, share, contribute, etc. all kinds of information.
Thanks to social trading, any trader (individual or professional) can share his transactions with the rest of the world.
Past transactions are transparent and can be studied/analysed by all traders; it is also possible to contact the trader who provides his transactions to ask him questions about his strategy, his trading method, etc.
Social trading marks a turning point (good or bad depending on opinions) in the way traders analyse and trade markets. Traders no longer only use so-called traditional analysis methods such as technical/chart analysis, fundamental analysis, or financial analysis; they can now use social financial analysis.
Which brokers offer social trading?
More and more brokers offer social trading: eToro, AvaTrade, XTB, IronFX, ActivTrades, FXCM, and many more.
A closer look reveals that more and more brokers offer their clients social trading.
Depending on the brokers, social trading takes different forms: Copy Trader, Mirror Trader, Social Trading, Community Trading, Trader Leader (Avatrade), OpenBook (etoro), etc.
Why have brokers started to offer social trading?
For a Broker, offering social trading is:
- offering a new tool to active and prospective customers, and being trendy.
- not falling behind the competition, and being at the forefront of technology.
And most importantly: social trading allows brokers to increase the number of transactions made through their trading platforms. Effectively, if traders copy each other (and also do manual trading), the number of past transactions is necessarily increased. And when there are more transactions, there are more commissions on spreads, and therefore more profits for the Broker.
An example: A transaction made by a normal trader generates for example €1 commission for the broker. If the normal trader is copied by 9 other traders, this same transaction is then passed 10 times, generating €10 in broker’s commission in total.
Who is social trading for?
We read on the net that social trading is intended for all traders (individuals and professionals).
In reality, social trading is more for amateur "traders", or ordinary people interested in the practice of social trading (copying other traders).
For experienced traders, social trading is an easy way to share their transactions in the financial markets. Some experienced traders are only interested in social trading if there is a possible reward.
Which traders to follow in social trading and how to choose them
As with all portfolios, if you practice social trading it is better to diversify the list of traders followed.
So don't follow just one trader, but follow several different ones, with different strategies, and trading different products.
Don't be a sheep; keep in mind that followers are usually sheep; they will follow what everyone else follows.
Do not only follow a trader for his past performance, or for the number of traders who also follow him.
The fact that a trader has a lot of followers or is highly successful does not mean that he will continue to be successful or that he is adapted to the trade portfolio that you are going to create.
Among all the traders you could follow, favour those with the best performance but whose maximum drawdown is the lowest, and who always position stop losses on their trades.
Avoid scalpers, i.e. traders who close their transactions with less than 10 pips of capital gain. Favour swing traders or day traders, who try to benefit from larger movements.
Finally, favour traders who have clearly explained their trading strategy and method. The clearer and more precise his trading strategy/method seems to you, the more you can trust him.
How much leverage should be allocated to traders followed in social trading?
When you follow a trader, you will have the opportunity to exactly replicate his transactions using your chosen leverage. It is important to allocate leverage measured according to the risk that you feel this trader incurs.
You can allocate more leverage to traders who don’t open many positions and who use stop losses.
On the other hand, limit the leverage allocated to traders who aggressively speculate on the markets and who do not place stop losses on their transactions.
The overall leverage allocated
If you follow several traders at the same time, you diversify your "trader’s risk", but you multiply the leverage allocated, and therefore the "overall risk".
An example: Let's say you follow 10 traders, all leveraged 1:1. If all the monitored traders open 5 positions at the same time, you will have 50 1:1 leveraged positions on your trading account, i.e. you will be using overall leverage of 1:50. With such high leverage, the risks of razing your trading account are enormous.
My criticisms of social trading
1/ Social trading is not useful for experienced traders. Brokers go so far as to pay traders who are followed the most, in order to make it interesting to experienced traders. What's in it for the broker? Obtaining experienced traders who generate profits and thus maximize the number of "small traders" who will follow them; this enables the broker to multiply the number of transactions made through his trading platform.
2/ Isn't social trading a way to interest amateur traders, or even traders who don't know anything about trading?
3/ Much like a PAMM, any trader can become a kind of portfolio manager. However, this activity is normally highly controlled. With social trading, nothing prevents a followed trader from making ultra-risky, highly leveraged, against the trend transactions, or on products with wide spreads (even better for the broker).
4/ The transactions made by a trader are not transparent enough for my taste. Some social trading platforms only display transactions closed by the trader; however, nothing prevents the trader from having a huge drawdown and only closing his positions that have capital gains. It is therefore very common to see so-called "best traders" with 100% winning trades and breath taking results. Does that seem normal to you? Moreover, these traders are generally the most followed. Nothing better to attract small individuals who know nothing about trading, right?