Social trading has become the norm in the last 3 years, especially for beginner traders and people who have started their investment journeys using online trading platforms. The main reason for this is that, as beginners, they often want to avoid the risk associated with their lack of trading skills while at the same time, increasing their chances of making profit. Indeed, this has given the opportunity to beginner investors and traders to profit from social trading.
However, simply copying other traders who appear to have an impressive performance isn’t the best idea, as beginner traders need to be aware of the different aspects of social trading that could eventually determine the success and trading performance of their portfolio.
Therefore, the quick answer to this question is: Yes! Social trading can potentially be profitable, provided you do it right. Social trading on the one hand is a great way to learn how to trade by following trading instructions, or on the other, enter the trading industry with a less risky approach by automatically mirroring successful traders.
But first, let’s understand what social trading is.
What is social trading?
Social trading is a relatively new investment discipline that arose as a result of Web 2.0 and as part of the evolution of social networks. Social trading enables investors to observe the trading behaviours of more experienced traders within a trading network, enabling them to imitate professional-level trades in order to achieve some profits.
Before social trading, copying other people’s trades through instructions was a complex task that required a lot of time and understanding of technical analysis. In the case that you follow the instructions at the time they are given, due to other aspects of trading unknown to beginner traders, the copied trade would have lost value in the time it took to undertake that analysis.
Social trading platforms are the “Facebook” equivalent of the trading world and are an excellent place for newcomers to spend time learning and copying from skilled traders.
Just like any other social network, you can learn more about other traders and their experience by clicking on their profiles. You can learn about their current trades, their trading strategy and their investment portfolio structure.
Although most information is freely available, certain platforms might incentivize traders to reveal their trades, or others who follow their trades may be required to pay a share of their profits to duplicate them.
One of the biggest benefits of social trading is the ability to communicate with other traders via comments or private chat. For example, if you’re curious about why a trader did something, you can inquire easily. However, note that not all traders are sociable and will be willing to share their knowledge with you.
Social trading can also help you overcome your fear of actually starting to trade. Some refer to this is ‘analysis paralysis’, which occurs when newcomers – even those who have done their homework – are too afraid to begin trading because they are over-analysing all of the data they have in front of them.
Overall, the social aspect is really helpful, as you can gain insight into what’s happening across the globe and what other traders are doing in relation to trading and investing.
Important aspects of social trading
1. Profitability
How much profit can you make from social trading? It really depends on the performance of the strategy you follow and your investment goals. If, for example, the performance of the trading strategy you copy has a return of 20% per year, but you withdraw your earnings at the end of the year, the profits you earn will differ vastly compared to sticking with the strategy for a 3-5 year period.
That, of course, is in the case that the strategy will continue to provide positive returns. Therefore, the point we want to make is that profitability for each person can mean a different thing. That is why it’s important to set clear investment goals and a clear investment horizon.
Profitability is not just about copying traders that have a positive return on their trades, but whether this potential profitability is aligned with what you want to achieve. Let’s not forget that at the end of the day, you are looking for a return on your investment.
2. Diversification
In social trading, you have the opportunity to copy not just one trader, but multiple. This in essence gives you the opportunity to build your own portfolio of traders and spread out the risk. With some platforms, you can add up to 100 different traders simultaneously.
Although this is a good from a diversification perspective, it will require a good initial analysis of the portfolio structure of each trader, so you avoid copying too many similar portfolios. Copying traders with similar portfolios is not considered diversification because you will not be spreading the risk.
3. Understanding risk
Many inexperienced traders make the mistake of assuming that just because a trader has been around for a while or has done a lot of transactions, they know what they’re doing, but this doesn’t always equal success. Conversely, they might be impressed by a very good performance, which is not backed by a successful track record of more than two to three years.
Anyhow, in either case, past performance does not guarantee future results.
Furthermore, it’s important to remember that when you evaluate a new trader, you need to analyse his or her score on the basis of portfolio volatility, which is a measure of portfolio risk.
Similarly, the maximum drawdown (MAXDD) is another important factor to understand regarding the risks involved when choosing which traders to follow. You might see a high performance but that high performance could also be associated with very high risk, which you can determine by checking the MAXDD (Maximum drawdown) of the strategy you are copying.
Maximum drawdown indicates the maximum amount the trader has lost from their overall portfolio during a given period. What we aim to point out is that it’s not just about performance, but about understanding key characteristics of a portfolio that are associated with risk.
4. Expectations
The ability to generate enormous gains with little investment is the main draw of social trading and copy trading for most people.
Advertisements and promotional materials for social trading networks and brokers frequently emphasise the enormous potential profits. If you take a look at the outcomes of the top-ranked traders on most networks, don’t be surprised if you find historical annual gains (ROI) of more than 100%, or even 500%.
People’s expectations are raised when they see these outstanding results. Many, however, are unaware that by maximising their prospective earnings, they are simultaneously maximising their possible losses!
5. Success fees
In order to determine profitability, you need to take into account the fees involved, which, at the end of the day, will be subtracted from your overall profits. Do note that when you copy a trader, as part of the service they provide, they will charge you a success fee. That percentage is not fixed – it is dependant per trader, and will be subtracted automatically from your profits.
6. Transparency of the platform
Choosing the social trading platform that you’re going to be using in order to find the right traders to follow is the first step in profiting from social trading. A real social trading platform will not hide important characteristics of a trader’s portfolio and will enable you to interact with the traders and ask questions in order to validate information if you need to.
The best social trading platforms will actually provide an overall score for each trader which is based on some of the various key characteristics described above in this article.
7. Performance monitoring
When using social trading platforms, be an active trader. Even if you’ve found a few excellent traders to follow, don’t think that’s all you need. If you stop paying attention at this stage, you could risk facing significant losses in the future.
Make a point of monitoring your performance. Analyze the trades and methods you’re interested in and monitor their performance over time, as there is a chance that the criteria you’ve set from the beginning with regard to your decision to follow these traders might change.
If you don’t put in any effort into your trades, you won’t learn anything, and you’ll most likely lose money in the long run.
So, is social trading profitable?
Taking into consideration the principles above, then yes, social trading can potentially be profitable. Since past performance never guarantees future results, no one should answer this question with a simple ‘yes’ or ‘no’.
Theoretically, you could follow a trader that is good and make money. In reality, though, this is not always the case because (and this is a fact) there are bad days in trading. In those bad days, you may question the traders you are following, and the decisions you make can impact your performance. Having patience, setting investment goals and knowing what you are trying to achieve is paramount.
An alternative to social trading, meet arty!
An alternative to social trading would be to copy a robo investment advisor such as arty. Since 2016, arty has generated annualized returns of up to 30% over various different portfolios, which you can copy based on your personal investment goals. arty offers you custom portfolios to choose from based on your preferred level of risk and desired target return, which you can then copy to your own brokerage account. It uses the latest AI technology to choose the most optimal allocations for your portfolio each month.
