What is social trading and is it right for your financial goals? Get to learn more about this online trading innovation tool in this guide
There are many advances in technology that the internet has enabled, foremost of these being social media. Social media itself has spawned yet another advancement in finance – social trading.
Some of the most prominent personalities who do social trading are considered financial influencers or “finfluencers”. Beginning investors, skilled investors, and finfluencers alike can all interact and exchange ideas about trading investment strategies. They often use message boards, online forums, and social networks on social trading platforms to do this.
This intersection of social media and online trading poses interesting questions:
- how does social trading really work?
- what tools are available?
- is it profitable?
Wealth Professional provides insight on these and more in this article.
What is social trading?
Social trading is a form of trading done online, with the help of social networking. Beginning investors or traders, experienced traders and brokers collaborate and exchange trading strategies and ideas via what’s known as copy trading platforms.
How does social trading work?
The key is using a common social trading platform. That’s where both beginners and more experienced traders and investors share their trading strategies and ideas.
On these platforms, they can look up expert traders, check their historical performance, and study their trading activities. Beginning investors can also ask more experienced investors questions before they choose to copy their moves and make the appropriate investment decision for their own portfolios.
Social trading is mainly about finding the trader that most fits your investment needs, then replicating their activity with a click of the mouse. Some social trading platforms in Canada even give you the option of subscribing to your favourite traders. Investors can choose to copy some or all the trader’s strategies, depending on their needs.
Strategies in social trading
Although social trading basically means mirroring or copying a trader, there are several strategies to it including:
Social following
This strategy entails following the trades and insights of other traders, stopping short of mimicking their portfolios and buying the exact same investments. This also means using the information shared by other traders to make their informed decisions on trading practices.
Copy trading
Also called mirror trading, copy trading is what it implies – replicating the trades of other traders. In this strategy, investors choose which traders to follow based on their risk profile, performance, and trading pattern. This is probably the best strategy for beginning traders, as it is low risk, following the trades of more experienced traders.
Portfolio mirroring
Instead of copying only the trades, this strategy involves copying another more experienced trader’s entire portfolio. This strategy can benefit traders who want to duplicate the performance of a particular investment strategy or trader.
Crowd trading
This strategy involves following the trades and insights of a group of traders, instead of one single trader. Using this strategy can provide a more diverse view of the markets and reduce risk.
Hybrid strategy
This is a strategy that combines some common ones. Usually this is a mix of copy trading, social following, and portfolio mirroring. By adopting this combination of social trading strategies, traders can enjoy a varied and well-rounded approach to their investments.
The pros and cons of social trading
As with any investment, there are advantages and disadvantages to social trading. Consider these factors before using social trading to assemble or manage your portfolio.
The pros of social trading
Can provide an additional revenue stream
Experienced traders who turn to sharing their knowledge on social trading platforms can get some money from those who copy their trades. Accounts that buy and sell based on your trades, then profit from them automatically give you a share of those earnings. These earnings are apart from the profits the experienced traders make on their own trades.
Explore social trading to amplify your investment strategy! From copy trading to engaging with a community of traders, see how collective wisdom can reshape your market approach. Dive into a world where transparency meets collaboration.
— Equaledge (@equaledge) May 30, 2024
Saves time
Using a social trading platform can save traders a lot of time, be they beginners, casual traders who want to learn about investments, or seasoned traders who want an added income stream. Instead of devoting entire days researching on which stocks to trade, social trading platforms can do much of the trading work and technical analysis for traders.
Enables portfolio diversification
Social trading can be a way for quick and relatively easier portfolio diversification. Thanks to the platforms doing most of the legwork, beginning investors or traders don’t have to waste time studying the financial markets. Traders also have the benefit of adding investments they may not be aware of or would typically add to their portfolios.
Can be a good networking tool
Finance professionals who don’t know many people in the trading world can benefit from the social aspect of social trading. These platforms can help you know about industry bigwigs or even help you get acquainted or introduced.
Some of the platforms also feature online forums so community members can share their knowledge and interact with each other. This can give you the chance to participate in meetings or events where online brokers, traders, and other professionals meet face-to-face.
The cons of social trading
Can be very stressful
It may not seem like it at first, since you can do social trading from your mobile device or computer from anywhere. Some experienced traders warn that you could follow the soundest strategies and still lose money.
When you reach a level where a lot of other traders begin to copy your moves, this can put quite a burden on your shoulders. As you get better and other traders copy you, find a balance between profitability and accountability.
The traders you follow may not be as knowledgeable as you think
There is a good chance that the “finfluencers” or traders you follow won't be much better than you at trading. Unlike licensed financial professionals, finfluencers are unregulated.
Remember, social networking sites and platforms attract all types of people, including those who are out to make a fast buck, and those who try to “fake it ‘til they make it”. Don’t take traders’ credentials or earnings at a social trading platform at face value – do a little research on them before copying their moves. Doing so is part of due diligence and risk management.
It's not the best way to learn about trading
Social trading is mostly copying and riding on the coattails of other, more skilled and experienced traders to (potentially) turn a profit.
This essentially means learning how to pick the best traders to follow and copy, but not learning which strategies would match your risk tolerance, and financial goals or needs.
What’s the difference between social trading and copy trading?
In social trading, traders can have access to a lot of different ideas from many social trading networks. Copy trading, on the other hand, mainly involves copying the trades of another investor.
The goal of copy trading is for the trader to have the same positions as the investor they’re following or copying. In copy trading, you don’t see the entire layout of the trader’s strategy and you follow their trades blindly. While social trading platforms may let you interact with another trader, you should be careful about using only a portion of their strategy.
A portion of a strategy is not what the copied trader does alone to achieve their financial goals. You can get into more trouble from following one person’s strategy than patching together pieces of strategies from several different traders, especially if you’re not sure about what you’re doing.
Past performance does not promise future results, especially in these unpredictable markets. You should look at trading history, going back at least five years. But keep in mind, that's only what’s happened in the past – and not investment advice for your future.
What are trading signals?
These are simply the function of an online trading platform that supplies traders with buy and sell suggestions. Typically, these are snippets of analysis that traders receive, informing them of possible trading opportunities.
Trading signals on a social trading platform are often human-generated or supplied by automated trading systems. They can be based on technical analysis, fundamental analysis, or both.
Here’s a video that demonstrates the basics of social trading platforms. The presenter here uses a popular one, eToro, to show viewers how to use the platform. You can see how to “copy” traders and find the most viable traders to copy. The presenter also gives a few useful tips towards the end of the video, so give it a watch.
Showing only the positive side of social trading and padding a finfluener’s followers with bots are some questionable practices. These are just a few reasons why Gen Z investors should be wary of finfluencers.
Is social trading safe?
In terms of their tools, social trading and its platforms are generally considered safe, since they often have the necessary cybersecurity measures in place. The practice of social trading, however, is another matter.
Most financial advisors would not recommend social trading. This practice lacks a very important process: there are no advisors to help keep their clients safe and ensure that they meet their financial goals.
When investors work with financial advisors, they help investors outline financial plans. This means looking at their client’s income, assets, and expenses, then figure out how they can safely invest and reach their financial goals. Financial advisors also ascertain their client’s financial goals and risk tolerance. These are all necessary to create a sound, holistic financial plan – something that social trading does not offer.
The CFA Institute has released a report on the growing role of finfluencers in investing. It also includes recommendations to improve financial literacy for younger investors, among others. Read our article for the full picture.
What are the risks involved in social trading?
The risks that come with social trading are the same as those associated with stock trading:
- market risk: social trading involves financial markets which can be volatile – even the most experienced traders can face losses
- systematic risk: these are economic changes, political events, or global health crises that can affect market conditions
- liquidity risk: market volatility and market changes can make it difficult to execute trades at desired prices
Social trading is an interesting by-product of the internet age and advancements in communication.
Tech-savvy, experienced investors will likely do better in social trading platforms than their less technologically inclined counterparts. This should be seen as a welcome addition to investing options in Canada.
Many experienced investors might shy away from social trading platforms, but they have their merits.
A sound approach to social trading would be:
- have minimal exposure to it
- use it for portfolio diversification
- use it as a learning tool for trading
Those who wish to profit from social trading are advised to practice due diligence in finding the right trader to mimic, invest cautiously, and most importantly, manage their expectations.
Social trading tools are among the many advances in fintech we can see at work today. Get more info on this and other innovations in our wealth technology section.
