What is Social Trading?
Social trading, presently, involves both the automated replication of trades and the ability of traders to interact and share their ideas and opinions about the market.
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The social trading journey started with the mailing lists and the newsletters. It later evolved into the trading rooms and the chat rooms. Then, came the turning point in 2005 when Tradecy automated the trade sharing and replication process by introducing the first auto-trading system called ‘Mirror Trader’ — a program through which accepted strategies are hosted by Tradency from where interested traders can mirror the trades generated by the strategies.
Later on, ZuluTrade and eToro made it possible for traders to just link their accounts and have it available to interested investors. They further introduced the chatting and interaction sections thereby making the trading a social thing.
The main components
These are the main components of social trading:
- The market: Social trading started in the forex market but with the advent of CFDs, eToro has opened social trading to other financial markets such as stocks, indices, commodities, bonds, and the cryptocurrency markets.
- The broker: The broker is like a travel companion in your sojourn in the financial market and is a very important component of social trading. You need a broker that supports social trading.
- The signal provider: This is a successful professional trader whose trades you want to copy. The platform provides you the data with which to evaluate the performance of the trader. The depth, accuracy, and reliability of these data are the most important elements for a correct selection of the best signal providers to follow.
- The follower: You are the follower looking for a successful trader to follow. You should have your objectives and risk tolerance and know how to translate them into practical and specific choices.
- The social trading company: They provide the platform that links your account to that of the signal provider. They act as a broker between your broker and the signal provider’s broker.
Signals replication process
This is an automated process which occurs within a few tenths of a second. It happens as follows:
- The signal provider opens a new trade, and his broker sends the data of the same trade to the social trading company.
- The company receives the data of the new trade, selects the investors who subscribed to the signal provider, and verifies their personal replication settings.
- The company then sends to each investor’s broker, the details for the opening of the new trade but modified according to the client’s settings.
- Each investor’s broker opens the order on its customer’s trading account.
The Signal Provider
This is a professional trader who has developed a profitable strategy and has a verified track record of success to show. A good way of assessing him is to look at his:
- Characteristics: This is evidenced by:
- How long he has been trading.
- The number of instruments he trades.
- The number of positions he usually keeps open simultaneously.
- The number of trades he executes on average per day or week.
- How long he keeps trades open on average.
- What the win rate is
- What the risk-to-reward ratio is
- Category: The style of trading he employs:
- Position trading
- Swing trading
- Day trading
- Martingale — very high winning percentage. Avoid him.
- Equity line and Drawdown: You must verify:
- The type of equity line — of closed trades only or both open and closed trades.
- The type of drawdown — of closed trades only or both open and closed trades.
As a follower, here’re the main factors to consider.
- The risks involved:
- Risks associated with the platform: Pay attention to the platform’s settings.
- Risks associated with the signal provider’s strategy: There is risk associated with different trading styles and strategies — position trading, swing trading, day trading, scalping, or martingale which is the worst. You need to dig deeper when assessing the signal providers. You will recognize a martingale trader by his extremely high win rates. It means he doesn’t close losing trades — avoid him.
- Capital allocation risks: To minimize losses, maximize gains, and maintain a proper risk level, you need to have a good capital allocation plan.
- Portfolio control risks: There’s a need to find ways of monitoring and balancing your portfolio from time to time.
- Money management principles: This basically involves:
- How many signal providers to follow?
- How much capital to assign to a signal provider?
- What lot size to assign to a signal provider?
- How and when to monitor and reassess the performance of each of the signal providers you’re following?
- Expectations: You will need to manage your expectations. Patience is the key. It will take time before you start seeing meaningful profits.
Trade replication has evolved over the years and became more popular with the advent of automated replication of trades. Though there’re risks involved, with due diligence and the right mentality, you can make money investing in social trading.
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