Social trading: a good or bad idea?
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Many novice traders are tempted to copy the trades of the best traders to generate profits in the financial markets. This is an easy solution that avoids going through the "Trading Training" box. This is what we call social trading. These days, a lot of brokers (eToro, avaTrade, etc.) and Internet sites (Zulutrade, Myfxbook, etc.) offer this service and they beat visitation records! In principle, they make you dream, make money without doing anything, but what about reality?
With trading, there are multiple investor profiles. They are distinguished by their trading style (scalper, swing trader, trend trader, against the trend trader), their trading time units (short, medium or long term) and also by their psychology.
This is the reason that two investors may have a different view of the same price chart.On drawing close to the resistance, for example, one will see an opportunity to trade against the trend while the other will see an opportunity to open a position in the direction of the trend to break the level. Some traders try to capture large trend movements by being ready to undergo correction movements, while others want to capture smaller movements without having to undergo these corrections.
This depends on the investor's psychology. That's why we tell all traders that they must find the trading strategy that suits them, one that is adapted to their investor profile. You cannot go against your nature as an investor in the long term.
Social trading is unnatural! You copy the trades of a trader who does not have the same vision of the market as you do. You simply look at the performance he generates but you don’t understand the mechanisms and elements that drive him to opening a position. When everything is going well, with performance on schedule, you don't say anything. The problem is that all traders, good or bad, have loss phases. Depending on market conditions, a trading strategy’s performance varies widely. Some perform better in phases of volatility, others when the market is calmer. These loss phases are part of trading, they are completely normal and it is impossible to win in the long term if you do not accept them.
The problem with social trading is that during loss phases, you question the trader you are copying. He is the only one responsible for the loss. Since you don't even know his strategy, you don't understand why he suddenly starts losing. You then say that this trader is bad and you want to change him. It is a completely normal psychological mechanism. We can accept a loss (with a greater or lesser degree of difficulty) when we have caused it ourselves, but we do not accept it when caused by someone else.
That's the problem with social trading, it can work for a short period of time but in the long term, your psychology conflicts with that of the trader you copy. This behaviour is also found in portfolio management. When the manager makes money for his clients, no one calls him, but when he goes through a loss phase, his phone keeps ringing," Why did you take this position? I don’t agree with you".
Never forget one thing if you copy a trader, it is you who made the choice. If you lose money, it's your fault. You don't pay him (unlike a portfolio manager), so he owes you nothing. So at least have the class not to complain on the forums, in times of loss, by claiming that trading is a scam.
For the follower, the objective is simple, it is performance. He will select the trader who generates the highest trading results. All results are associated with a level of risk. In general, the higher the result, the greater the risk. Quite often, followers forget the notion of risk (which is measured by the drawdown).
To attract a large number of followers, the trader tries to generate as high a result as possible while knowing that he is taking significant risks to achieve this. If he takes a measured risk, he knows that he will have very few social trading followers. For him, followers are a means of remuneration. The more he has, the more commissions he gets on each trade. Effectively, the broker who offers the social trading service pays him a part of the commissions received on each transaction (with the spread).
In the end, these commissions represent more than the results the trader can generate on his trading account. His interest is therefore to maximize his number of followers and therefore his earnings. The problem is that by taking risks to generate performance, he ends up paying for it. He loses all or part of his capital on a losing series of trades. As a result, he wins because of the commissions he receives from the broker, but for you, it's another story.
Copying a trader, without thinking, through a social trading platform is not a solution. This does not mean that you cannot copy a trader, but under certain conditions:
- You need to understand his trading strategy: The trader must be able to explain the reasons for opening a position (in broad terms). You must agree with him. Do not choose, for example, a scalper if you are more of a swing trader. This will ensure that you do not question his trading strategy during loss phases.
- Time is proof of reliability: First, you can eliminate overly recent traders (only a few weeks or months) who do not really enable you to judge the risk. If he has just begun to trade, you cannot know if he is reliable, if he knows how to overcome loss phases (see psychology in trading). Those who earn money are not those who try to earn money but those who think about lasting in the financial markets!
- Risk/return ratio: To judge the suitability of a strategy, you must compare the strategy's results with its associated risk. It is better to choose a trader who has a maximum drawdown of 4% with results of 15%, than a trader with a drawdown of 15% and results of 30%.
If you follow all these conditions, you will see that you do not have many traders left to copy on the social trading platform.
If you decide to do social trading, you should not copy a trader blindly. You must try to understand how his strategy works and, above all, make sure that he manages his risk perfectly.
Social trading is not a bad thing in substance but is in contradiction with a basic principle of trading: "Each trader has his own strategy". In addition, the functioning of social trading platforms (traders' commissions) calls into question the model’s suitability.
Each trader has a different profile
With trading, there are multiple investor profiles. They are distinguished by their trading style (scalper, swing trader, trend trader, against the trend trader), their trading time units (short, medium or long term) and also by their psychology.
This is the reason that two investors may have a different view of the same price chart.On drawing close to the resistance, for example, one will see an opportunity to trade against the trend while the other will see an opportunity to open a position in the direction of the trend to break the level. Some traders try to capture large trend movements by being ready to undergo correction movements, while others want to capture smaller movements without having to undergo these corrections.
This depends on the investor's psychology. That's why we tell all traders that they must find the trading strategy that suits them, one that is adapted to their investor profile. You cannot go against your nature as an investor in the long term.
Social trading goes against the investor's psychology
Social trading is unnatural! You copy the trades of a trader who does not have the same vision of the market as you do. You simply look at the performance he generates but you don’t understand the mechanisms and elements that drive him to opening a position. When everything is going well, with performance on schedule, you don't say anything. The problem is that all traders, good or bad, have loss phases. Depending on market conditions, a trading strategy’s performance varies widely. Some perform better in phases of volatility, others when the market is calmer. These loss phases are part of trading, they are completely normal and it is impossible to win in the long term if you do not accept them.
The problem with social trading is that during loss phases, you question the trader you are copying. He is the only one responsible for the loss. Since you don't even know his strategy, you don't understand why he suddenly starts losing. You then say that this trader is bad and you want to change him. It is a completely normal psychological mechanism. We can accept a loss (with a greater or lesser degree of difficulty) when we have caused it ourselves, but we do not accept it when caused by someone else.
That's the problem with social trading, it can work for a short period of time but in the long term, your psychology conflicts with that of the trader you copy. This behaviour is also found in portfolio management. When the manager makes money for his clients, no one calls him, but when he goes through a loss phase, his phone keeps ringing," Why did you take this position? I don’t agree with you".
Never forget one thing if you copy a trader, it is you who made the choice. If you lose money, it's your fault. You don't pay him (unlike a portfolio manager), so he owes you nothing. So at least have the class not to complain on the forums, in times of loss, by claiming that trading is a scam.
Contrary objectives in social trading
For the follower, the objective is simple, it is performance. He will select the trader who generates the highest trading results. All results are associated with a level of risk. In general, the higher the result, the greater the risk. Quite often, followers forget the notion of risk (which is measured by the drawdown).
To attract a large number of followers, the trader tries to generate as high a result as possible while knowing that he is taking significant risks to achieve this. If he takes a measured risk, he knows that he will have very few social trading followers. For him, followers are a means of remuneration. The more he has, the more commissions he gets on each trade. Effectively, the broker who offers the social trading service pays him a part of the commissions received on each transaction (with the spread).
In the end, these commissions represent more than the results the trader can generate on his trading account. His interest is therefore to maximize his number of followers and therefore his earnings. The problem is that by taking risks to generate performance, he ends up paying for it. He loses all or part of his capital on a losing series of trades. As a result, he wins because of the commissions he receives from the broker, but for you, it's another story.
Should you copy a trader on a social trading platform?
Copying a trader, without thinking, through a social trading platform is not a solution. This does not mean that you cannot copy a trader, but under certain conditions:
- You need to understand his trading strategy: The trader must be able to explain the reasons for opening a position (in broad terms). You must agree with him. Do not choose, for example, a scalper if you are more of a swing trader. This will ensure that you do not question his trading strategy during loss phases.
- Time is proof of reliability: First, you can eliminate overly recent traders (only a few weeks or months) who do not really enable you to judge the risk. If he has just begun to trade, you cannot know if he is reliable, if he knows how to overcome loss phases (see psychology in trading). Those who earn money are not those who try to earn money but those who think about lasting in the financial markets!
- Risk/return ratio: To judge the suitability of a strategy, you must compare the strategy's results with its associated risk. It is better to choose a trader who has a maximum drawdown of 4% with results of 15%, than a trader with a drawdown of 15% and results of 30%.
If you follow all these conditions, you will see that you do not have many traders left to copy on the social trading platform.
Conclusion
If you decide to do social trading, you should not copy a trader blindly. You must try to understand how his strategy works and, above all, make sure that he manages his risk perfectly.
Social trading is not a bad thing in substance but is in contradiction with a basic principle of trading: "Each trader has his own strategy". In addition, the functioning of social trading platforms (traders' commissions) calls into question the model’s suitability.
