Introduction

Wed 03 February 2016

Filed under misc

Social trading - also known as 'copy' or 'mirror' trading is a new way to place trades or longer term investments using the wisdom of crowds. For those who find the financial markets both appealing and daunting in equal measure it offers a way to 'follow' traders whose approach you value and mimic their trades in real time, profiting from their gains or sharing in their losses.

As Wikipedia puts it:

Social trading allows traders to trade online with the help of others and some have claimed shortens the learning curve from novice to experienced Forex trader.[4] Traders can interact with others, watch others take trades, then duplicate their trades and learn what prompted the top performer to take a trade in the first place. By copying trades, traders can learn which strategies work and which do not work.[5]

While it has been argued that social trading encourages a more hands-off approach which could make aquiring trading skills take longer, for many this is part of the appeal. Some love the thrill of placing trades by themselves, while others would prefer to put their capital in the hands of a fund manager.

A social trading platform not only allows you full transparency into the past performance of any particular trader, but access to experienced traders without the high minimum deposits needed to work with a professional hedge fund or wealth manager.

This is the lure of financial trading for profit. As the popular BBC programme Millions by the Minute has shown, the dream seems to be gaining hold. It appeals to parents who hope to be able to squeeze in some profitable trading between school runs. And it is equally a way out for those who simply don’t want – or don’t fit into – the corporate world of the office. Now the world of social media has added an additional, attractive twist to the dream of being your own boss and making a killing. With “#copy trading” – which enables you to mimic the investment moves of the “professionals” – you can supposedly cash in even if you know nothing at all about the markets.  

Social Trading Networks

There are a growing number of social trading platforms. These come in many forms, from fully fledged  social networks such as eToro and Ayondo, offering discussion and friendship with built in trading facilities to those that operate on a more technical basis such as Zulutrade, forming the glue between traders who may be placing their trades with entirely different brokers. SocialTradingGuru has a nice run down of the current players in the market.

Is it safe to use social trading platforms?

As the  FT points out, opinion is split on whether the boom in social trading is a good or bad thing:

For its supporters this “social trading” is democratising the world of investing by reducing the traditional disparity in trading resources between large and small investors. For critics, this increasing accessibility opens up huge risks for uninformed traders, emboldened to bet big without performing their own due diligence. [...]

On eToro, traders’ transactions are automatically posted on their profiles, or “walls”, and others on the platform have the option of automatically allocating part of their portfolio to following their strategies. Such copy trading effectively turns every trader into a micro-mutual fund that can be invested in by others.

[...]

In addition to earning money from the site for each imitator she attracts, being a respected influencer brings social benefits as well. “It’s kind of lonely being a trader,” says Ms Haisma. “With eToro you can put something on your wall and somebody always will comment on it.”

Critics say that new users have a tendency to follow the traders with the best short-term performance – a feat usually achieved through risky strategies that have the potential to blow up spectacularly.

“We always try to communicate the risks,” says Yoni Assia, eToro’s chief executive. “It’s a social system, so it requires an understanding that copying somebody else is for better or worse.”

 
In the early days it was commonplace to see brokers highlighting traders with seemingly impossible gains, or unbeatable winning streaks. But both copiers and platforms alike have realised that traders who  never lose are often holding positions open for unnaturally long periods of time. As SocialTradingGuru explains,

Look at the number of Open Trades in the eToro trader profile. As above, open trades will significantly impact your overall performance as they reduce your available equity. Professional traders know when to take losses and use stop levels effective. We therefore prefer traders who cut their losses before they become a drain on the available equity and eventually get stopped out. I.e. traders with no open trades and a 60-80% winning ratio will perform better over time than traders with a 100% winning ratio and 10+ open trades.

Always be very sceptical about traders on eToro who have a 100% or very high winning ratio. Anyone can have a 100% winning ratio by never closing a losing trade, but this might significantly impact your performance.

 

Finding the best traders on Etoro, Ayondo or Zulutrade

In order to find the best traders to follow it is important to take your time to do your own research. There's a wealth of factors to consider, but ForexOp have summed them up the key factors to consider quite nicely:

With around 2.5 million traders to choose from on eToro, selecting the best can be quite a daunting task. Fortunately, I have some pointers which will help you to select those traders who are most likely to deliver consistent, profitable returns over the long term. Here are the criteria I use:
  • Must have at least 12 months trading history
  • Must be active (at least 1 trade per week, over the last 12 months)
  • Must have a consistent performance with no drawdowns greater than 25%
  • Must have an annualized return (realized profit) of at least 25%
  • Must be at least 95% manual
  • Must have at least 85% win ratio
  • No more than 20% high risk trades
 

These are echoed by other blogs on the subject, such as this from Feint.me:

Be Picky When Choosing Who to Copy

It's tempting to follow the traders with 400% returns. But a quick bit of research (and common sense) will tell you that these traders are using high risk strategies. Look for someone with a majority of low-medium risk traders, and a low weekly drawdown

Diversify

By copying as many traders as your budget will allow, you're able to mitigate the risk of having your entire investment wiped out by a single trade.

eToro Stocks are a Good Way to Diversify

I've found that traders who invest in both forex and stocks provide more reliable returns over the long term

Choose Frequent Traders to Copy

You don't want to be stuck copying a trader who only logs in every couple of weeks. Look for gurus who make frequent trades.  

 How to get started making money with social trading

Your first step as a novice trader should be to locate the experts you want to follow/copy. The bulk of your work on eToro, at least in the initial period, will be following your experts for at least an hour per week to see how they are performing and decide whether you’d like to switch and change your portfolio. You can easily access each expert’s history graph once a month. Even the best traders experience losses. You should become aware of when it’s time to close a failed transaction. Closely watch your experts and react to negative trends by un-following a poorly-performing expert. Don’t hesitate to shut down un-profitable/negative trades – successful trading is all about long term profits.

 It is vital to weigh up which traders are going to perform over the longer term - risky strategies with absurdly high returns are appealing but short lived. It's much better to pick traders that will deliver consistent, realistic gains. Compounded over the long term this is the sure way to build wealth.


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Social Trading © Birgit