Social trading was a concept introduced into the forex market in 2006. The idea was to provide a system where traders with expertise could sell this knowledge to other traders who were less experienced or knowledgeable, in the form of trading signals. To put it in another way, the social trading platform would provide an engine which would permit less experienced traders copy the trades of the experienced ones, while engaging further on a less formal basis on the blog section of the platform. Those who copy the trades would pay a token for them, which would be split between the platform provider and the traders being copied.
The concept of social trading arose out of a great need to shorten the learning curve of traders, and to get them to start being profitable. What better way than to directly pick the brains of those who were already ahead in the game, and to do it in a symbiotic atmosphere where everyone in the arrangement would benefit.
- The expert traders (known as Leaders) would get paid by each trader that followed them and copied their signals. Considering that some Leaders get as many as 3,000 followers, this arrangement could provide a great second income stream for such Leaders.
- Inexperienced or unprofitable traders (the Followers or Investors) who choose to copy the trades of the Leaders end up paying a token to get potentially profitable signals sent their way. This arrangement gives them a good chance to profit from the market.
- The platform providers who bring Leaders and Followers together also get a portion of the payments for their services and for providing the copy trade engine.
Is Social Trading Overrated?
A look at the institutional trading setups will show that trading is essentially a social activity. A typical dealing desk department which takes in orders from traders and decides which to fill in-house and which to route to the interbank market, is made up of teams of up to 30 persons. These persons do different jobs and they work cohesively to ensure that the market making operation remains profitable.
When we look at prop trading firms and institutional/commercial trading entities like the dealing desks of investment banks or hedge funds, we also see that these are made up of teams with an established order of hierarchy among traders. This hierarchy is derived purely by merit and level of expertise.
But the picture is very different when we get to the retail end of the market. Most individual traders are lone rangers who operate without help or mentorship. There is no oversight, and no one to take such traders by the hands and show them the way in a market where it is easy to get lost in the maze. The end results are therefore hardly surprising: 90% of these traders will lose their accounts in 90 days. In contrast, nearly all institutional trading setups are profitable to the tune of 95%.
From this analysis, it is easy to pinpoint the problem: individual traders trying to go it alone or do it all by themselves, especially when there has been no period of training or mentorship.
Social trading has therefore emerged as a concept to help bridge this gap, not just by enabling losing traders copy the profitable ones and hopefully turn things around, but also providing a platform for engagement with these traders in the blog sections, so as to understand the thinking behind the Leader’s strategy and trading styles. This last bit is what separates social trading platforms from the regular signals services that only give out fish (signals) without teaching the subscribers how to catch fish on their own.
What Should a Social Trading Broker Provide?
The key to a successful social trading career for any Follower is the ability to select good Leaders. It is a process that requires some form of know-how and is not something to be taken lightly. The job of the social trading broker is to provide a platform that helps Followers pick the right Leaders, weeds out traders who are not qualified to be classified as Leaders, and enable only those who have the right credentials to serve as Leaders on these platforms. We have scanned many of these social trading platforms and can authoritatively state that many of them lack these basics.
This is why we have developed a template that was used in selecting the social trading providers listed below. The metrics used in composing the selection template are stated below.
A) Profitability Chart
It is not enough to simply see Leaders on the dashboard with profit stats that run into 3 or 4 figures. You have to know the facts behind the numbers. How can you detect a Leader who overleveraged a position and used a trade size that was beyond risk management limits, to achieve one-off results that pushed profitability stats into the 3-figure range? This is where the profitability chart comes in. Here, we look at how the trader’s profits were made. A chart that slopes upward at a 45 degree trajectory is a good indication that proper risk management in several trades, and not excessive risk in a one-hit-wonder, is the reason behind the profit stats. In contrast, a choppy chart which shows steep slopes to the upside and downside, is indicative of huge risks taken in trades, leading to sharp jumps or sharp falls in the chart. A social trading broker should be able to provide this chart for Leader selection.
B) Risk Score
The Risk Score is an internal algorithm that is used by the social trading platform to calculate how conservative or risky a Leader’s strategy is. It is usually graded from 1 – 10, with lower figures being the more conservative and the higher figures resulting from riskier strategies. Any social trading broker worth its salt must provide a Risk Scoring algorithm to make it easy for beginners to select Leaders whose strategies are not excessively risky.
C) Time Graphs
How can you tell traders whose performances are based on only 1 month’s history, and those whose performances are as a result of 1 year’s trading and therefore of greater reliability than the former? This is why time graphs or at least an information bar which states how long a Leader has been trading is something a social trading broker must provide.
D) Ease of Copy Trade Application
It is not only on the side of the Followers that a social trading broker needs to provide certain facilities. Leaders worth their salt also deserve to have the best that a social trading broker can provide. For instance, it should be easy for traders proposing to be Leaders to get proper ranking and evaluation based on parameters that actually matter. It should also be easy for Followers to copy a Leader that suits their preferences. The social trading platform should also provide a Leaderboard that should be easy to work with. Leaders should not suffer from revenue loss because the display algorithms make it hard for Followers to find them. These are things that a social trading broker should be able to put in place.