All traders, experienced and beginners, make up the trading community. Of all the platforms they can use to chat and share ideas, social trading networks are just one of them. Let’s see what these digital platforms are about, their pros and cons, and also some study cases to find out whether they really work.
What is Social Trading?
In short, Social trading allows the investors to observe expert trader’s moves in the market. First, it is low-cost, sophisticated, and requires little knowledge of financial markets. Second, its aim is to allow inexperienced traders to mirror other investor’s strategies, including industry pros.
These platforms facilitate the free exchange of information between the users. Subsequently, this permits them to trade collaboratively and transparently. Likewise, network members their information comes from trust-worthy sources .Before e social trading developments, trader’s decision-making process relied on the analysis of their previous investments. Click To Tweet
Finance Magnets describes Social Trading as platforms that “allow customers to connect with other traders and follow their trades”. They allow followers to see strategies, descriptions, historical returns, bios, and more.
According to the World Economic Forum. Social trading empowers individual investors to build and share investment strategies and portfolios with other investors;
“empowers individual investors to share their opinions and gain market insights from the opinions shared by the crowd,” and “offer effective means for individuals to share or sell their investment expertise, directly competing with traditional investment managers.” The institution also considers that social trading platforms are part of the investment management future.
There are three main types of trading. Let us see how they work:
It happens when a trader places a normal trade. It’s a no-social trade.
This section will talk about how copy trading allows traders to copy open positions made by other people. It lets traders copy a specific strategy and implement it the same way another trader – also called leader or signal provider – is performing it.
This trading type allows traders to mimic other traders’ behaviors indirectly by analyzing other’s information and data – or directly by copying other investors’ strategies with one click.
Most importantly, if you are a signal provider, you can be compensated with a monthly fee from your subscribers. It is a way to motivate senior traders to let other traders copy their strategies.
Copy Trading impulsed the development of a new type of portfolio: A “People-Based Portfolio”. On it, some fund investments are given to other traders and not to the market.
With Mirror trading, the trader copies the exact same movements of another one. A prime example is that a trader can select to mirror specific strategies that match their preferences; like the market they are investing in, the risk and the profit, investment capital, or investment goals. It is mainly used in the Forex Market but it’s also common in the Stock market.
Social Trading Benefits
- You can find plenty of relevant, useful, and valuable information
- Provides you with reliable investing information
- It reduces the time and the costs to become an experienced trader
- It’s a great tool to use when a trader does not feel ready to operate their investments by themselves.
- Gives you access to collective knowledge or the collective perspective about a specific issue, platform, investment, practice, etc.
- It’s a great first-hand insight provider
- You may start earning from the beginning
- Furthermore, you may learn how to improve your risk management skills
- Allows you to discuss your strategies and, therefore, be aware of the best possible outcomes
- You have the ability to learn from more experienced traders. Network with them & others, and even get the chance to collaborate with other investors
- Connect with traders that think alike
According to the Jindal School of Management at the University of Texas these are the 4 major benefits of Copy Trading:
- More transparency since investors will observe every single trade of a trader.
- Higher-level of control since the execution is done in the investor’s own account.
- More reasonable fee (compared to funds), typically zero management fee and 20 percent when there is a gain.
- Preventing potential manipulation that may occur in the financial advising industry.
Social Trading Cons.
- Most of the time, you don’t personally know the professional trader you choose to follow.
- There are people that will try to create a false profile to get followers.
- When you choose to follow a trader that has had 15 or 20 successful trades in a row. You have to take into account that at some point his/her streak will get cold.
- Non-experts also share their thoughts regarding the market and the best moves to make. This means you still have to do your own research before trading.
- There is a high chance that professional traders risk a low percentage of their assets. Beware of this if you are planning on doing risky trades with a high percentage of your money or assets. Because if something goes wrong, your account can be wiped out quickly.
- As a new trader, you are easily influenced, so don’t believe everything the first person who seems knowledgeable tells you .
NOTE: When choosing a platform, pick one that mitigates these possible obstacles, such as TradeGATEHub.
Social Trading Case Studies
As we have previously seen, Social Trading has plenty of benefits. So, let’s take a look at what experts have found about this financial social trend.
1. Social Influence in the Financial Trading Network
- The subject of study: Social Trading Network (STN)
- STN Analized: eToro
- Sample: 5.8 million trades from August 2010 to January 2012
MIT Media Lab to measure the role of social mechanisms in the financial system.
Among the 5.8 million trades:
3 million trades are non-social independent trades, and around 2.7 million trades are automatically executed mirror trades. The rest are “copy trades” that users manually copied from other users’ trades.
On it, researchers found that the eToro financial system had 2 major challenges:
- Have certainty on whether one can get optimal decisions based on “Crowd wisdom” reliability. This is as according to researchers, the collective driving force behind the decision-making process is real money.
- Get to understand how crowd dynamics alter social influence.
The study authors come to these conclusions:
- The crowd has much better results than an average individual
- The crowd is subject to social influence dynamics and not to rational thinking.
The graph below shows the mean return and Sharpe Ratio. (Sharpe Ratio=Mean Return / Risk) for both the Simple Best and Social Best Strategies.
2. Social Trading and the Transparency – Revenue enigma
The Jindal School of Management at the University of Texas did a research study aiming to analyze Social Trading transparency. According to the authors, there are 2 aspects involved in information transparency.
- The type of information that should be disclosed: What is relevant for the traders and users?
- The timing of information disclosure: When should be best to make the best decision-making process?
In their study, they focus on the timing, crucial to potential investors to evaluate who to follow.
If there is a delay, users will stop following experienced traders, since they can get the same information for free. Therefore, real-time information release affects investors that get profit from their followers.
(Figure 2) illustrates a hypothetical trade. If there is a time delay, both the Open and Close time move affecting .
3. Social biases on trader performance in social trading
In their paper for the Journal of Information Technology, Florian Gleser, a Goethe University Frankfurt researcher (Germany), and Martin Risius, a researcher from the University of Mannheim (Germany) analyzed the social biases on trader performance in social trading. Their focus was on the effects of transparency.
Their main finding was on social trading platforms. “The traders’ sensitivity to the asset’s disposition effect is influenced by the amount of attention they receive from their followers”.
This means that the asset disposition changes as the amount of attention or traders replicating their trading movements varies.
4. Institutional Aspects of Social Trading Networks
Philipp Doering, Sascha Neumann and Stephen Paul on their research paper for the Department of Finance and Banking at the University of Bochum, argue that Social Trading platforms reduce the information gap or information asymmetry between the traders. How they share their investments ideas and the traders who subscribe to senior traders accounts to follow their lead. The study timeframe was the year of 2012.
They conclude that the platforms act as an intermediary between investors and signal providers, aiming to reduce information asymmetry. Provide detailed track records, rankings and search functions.
This makes Social Trading more reliable and with higher levels of transparency than other portfolio delegation.
The authors also note that signal providers are not subjected to any investment guidelines, which may lead to misinformation.
5. Traders Interaction and relations within Social Trading Platforms.
Matthias Pelster analyzed the interaction-based relations of traders from a large social trading platform. In his study I’ll Have What S/he’s Having: A Case Study of a Social Trading Network.
He found that the interaction-based relations are mostly performance-driven. In addition, the interaction-based relations of social trading networks have the potential to increase momentum and market fragility.
6. More Study Cases:
If you want to learn even more about what researchers have found so far about Social Trading and how it affects the Trading Community you can also reach these studies:
- About the fear of reputational loss: Social trading and the disposition effect
- More than just financial performance: Trusting investors in social trading
Social Trading Platforms
There are plenty of social trading platforms you may use. If you haven’t looked into what social trading is and how to effectively take part, check out this article.
Social Trading platforms are out there for beginners and for professionals. Be part of the Trading Community and become a skilled trader each day! Try Social Trading with TradeGateHub, your toolkit for trading success, and access to Institutional analysis, real-time news, professional traders, a centralized platform, and learning education for Free. What are you waiting for? Click Here. Let’s do it!