Social Trading is a type of investment where one trader instead of observing the market, studying it, and making educated decisions about when to open and close the trade, observes another professional trader’s decisions and just copies them. It may sound lazy but for a lot of people, this is quite a sweet spot to be in due to the fact that they do not overburden themselves with different aspects of trading and just let themselves relax in the evenings having one less worry in their lives. Although, trading is not as straightforward as some would think and even professional traders end up losing lots of their assets.
It is also worth noting that most of the social trading is done on assets since this is where the highest concentration of traders takes place with the Forex market being close 2nd in its popularity. There are always pros and cons to dealing in either of them but the Forex vs stocks argument is a huge point of debate and is outside of the scope of this article. However, what you as a reader need to know is that Forex is preferred due to a wider range of markets that are available while stock traders have more in-depth data about assets that they deal with thus making it feel safer to trade. The arguments usually boil down to the payouts, difficulty, and centralization and come down to the preferences of the trader.
A lot of research has been done by reputable institutions about social trading. One such instance is the Massachusetts Institute of Technology’s computer scientist and the researcher Yaniv Altshuler, who described social trading networks, in his comprehensive paper, as extremely complex and adaptive systems. He did a very thorough research about one of the social trading platforms stating that:
“Having the inherent ability to share ideas and information with each other, OpenBook’s users are given a new source of information they can use in order to enhance their trading performance. As the users are not playing against each other but rather – against the market, this situation becomes a non-zero-sum game, hence incentivizing the users to share as much information as possible.”
“social trading provides much better opportunities for profiting compared with individual trading,” but that users make “excellent but sometimes not optimal decisions in selecting experts when they can see others’ choices.”
Apart from MIT’s interest, the World Economic Forum, or WEF, has written a report stating that social trading networks are extremely disruptive to the traditional practices of wealth management since it empowers customers to have alternative low-cost systems in place.
Unfortunately, social trading results in higher pressure for those who are being followed. In 2017, St. John’s University has written a study about “leader traders” where they have made a point about leading traders being more susceptible to the disposition effect than those who have no following. The paper talks in detail about the effect of giving financial advice and the disposition effect in the online trading environment. This is due to the fact that the “leader” feels responsible for his or her followers and has an insatiable urge to not let them down fearing the loss of said people who put their trust in them.
Key Features of Social Trading
There are some key features that need to be paid attention to when discussing social trading. It is important to note that this is by far not a full list but some of the main ideas, which are the leading causes of people trusting such endeavors.
- Information flow is one of the most important aspects as unhindered access to information is extremely important in the financial market. Information is the tool, with which the professional traders determine the way the market will flow and make educated decisions about when to open or close the trade. Because of this, the free exchange of information is a key to any investor.
- Trading cooperation is the main idea around which social trading is built on. This means that traders from all over the world and different backgrounds create trading teams and trade in collaboration with each other. This means that they directly increase the worth of the social trading platform due to the accumulation of data the individual traders bring in on the market share.
- Transparency is the leading cause of a lot of cooperative behavior between traders. Social trading platforms do not hide the statistics of individual traders, thus, the open and past positions, market sentiments, and trader performance statistics determine the trustworthiness of an individual investor making others interested in following them. This means that nobody is able to exploit the system and manipulate the market due to the simple fact that people can easily notice and stop following them. It increases the integrity of the “leader” traders.
In conclusion, social trading is a way for people to copy other professional traders’ decisions and try to make a small buck out of it. It is an interesting strategy, which leads to gains without much effort, however, there is always risk involved that the trader you are following is going to make a wrong decision and thus cost you your gains. Due to this, it is always recommended to trade with smaller amounts rather than big ones to have that space for mistakes. One cannot blame the “leader” when it is your choice to follow.