Follow the Leader: Social Trading and Copy Trading

In recent years, social trading and copy trading have become increasingly popular for investors and novice traders. What are they, who are they for and  what are the risks associated with them?

Briefly, social trading is a type of trading that allows traders or investors to see, discuss and – if they wish – to execute the strategies of their peers or, more often, experienced traders. It is all about sharing knowledge to help you act and is done via a social trading platform.

Within social trading, there are sub-types that is known as copy trading and mirror trading. Copy trading allows followers, as the name suggests, to copy exactly the trades of other traders. This can be done either automatically or manually., also via a social trading platform.

There are a number of brokers offering social and copy trading. The most well-known is eToro, which declares that it has a “community with more than 20 million investors from over 100 countries.”

Why it May be Useful

The first benefit of social trading for some people is that it saves time, especially copy trading. You do not have to do any backtesting or forward testing of your own strategy, for example.

It also, in theory, allows you to avoid common newbie mistakes, particularly emotional trading and overtrading, since you are following or copying traders who, presumably, do not make such errors.

A surprisingly large range of people find social and copy trading useful. Traders who wish to learn from a community, hands-on traders who make their own decisions but based on the moves of already successful peers, traders and investors looking to learn and develop trading strategies, as well as the more experienced who wish to network and establish an extensive reach all engage in social trading.

Depending on you, who you follow and how you follow, both social and copy trading are a good way to learn trading and investing. For social trading, you are in effect learning by doing, while copy trading is more hands off. On the other hand, a great advantage of copy trading is that by mimicking the moves of experts, you can trade well beyond your abilities, experience and knowledge.

Lastly, although this is not necessarily a big attraction for some, you are in a community. You may interact with others in the same position and, what is more, you will get notifications, trading alerts and so on. You are not alone.

Why it May be Risky

Firstly, while social trading helps to relieve some of the burden of planing, decision making and acting, you are ultimately responsible for your trades.

The prime disadvantage of social trading is that you can rely too heavily on the competence of another, and it all comes down to whether you have made the right choice of trader and platform.

The traders you follow are not necessarily professional traders. They may be just more experienced or more successful versions of their own followers. It is very important to remember that you are following them based on their past performance, and of course this is not a guarantee of future performance. In a few cases, the followed trader’s strategy may not be transparent enough.

There is also the tricky conflict inherent in any social platform. Social trading platforms want to promote star traders to attract more followers and users. Stars may be encouraged to take risks to gain ever more visibility. The platforms may not act exclusively in the interests of their users.

Regulation, while not an issue for the established social trading platforms, can be for some depending on the country they are based in. Additionally, in a few countries copy trading is in a legal gray area. It may bypass laws on the safeguarding obligations normally required to manage a third party’s money, because it is seen as an automated and semi-automated advice and portfolio management service.

In any trade, losses can occur very quickly and if they are inexperienced, this could be a problem for copy traders due to the automatic duplication of orders. To deal with this, some platforms have introduced what are known as Copy Stop Loss orders and have made them obligatory for copy trades.

Finally, as for any service, you should pay attention to any fees charged, although most social trading platforms are very transparent in this respect.

The Wisdom of the Crowd

A lot of people can benefit from social trading and copy trading. Whether you wish to meet other traders, discuss trading strategies, gain insight into investing, or take a hands-off approach to trade, you have options.

Copy trading is ideal for those who want to leave the big decisions to others and certainly reduces the chance of overtrading, especially if those you copy are professional traders.

A big selling point for both social and copy trading is that they offer an easier entry into trading. However, the bottom line is that it is still trading and that is inherently risky.