Going Social: A Guide to Social Trading
We really are living in a golden era for aspiring traders. One of the latest developments in this field has been social trading – an extension of social networks like Facebook. Trading is a lonely endeavour, so it's only natural that Social Trading platforms would gain traction.
Aspiring traders can get in touch with experienced traders; traders that trade part-time or have little time to follow the markets can create a portfolio of successful social traders to manage their risk capital. This short guide will help you understand the advantages and potential pitfalls of Social Trading, how to select signal providers, and how to become a risk manager overseeing the performance of your signal providers.
What is Social Trading?
Initially, social trading networks were created as an extension of social media platforms like Facebook or Twitter. The possibility to stay in touch with like-minded individuals was the most evident benefit, but additional benefits followed. It became possible to illustrate in real time which trades were being taken. Nowadays, Social Trading platforms are online networks where retail traders have the opportunity to copy strategies of top-ranked traders. Basically, the retail trader links their account to the master account, and the trades are copied and scaled to the trader’s account balance.
But the perks are not limited to “copy-trading”. There can be instances where traders are specialized in one market or another, and having access to their views can potentially be an advantage. Moreover, there are many strategies available to choose from – this diversity of agendas and objectives makes for a healthy two-way marketplace.
How does it work?
Broadly speaking, you first open a trading account with a broker like Pepperstone. Then, you can join a social trading network and the process usually goes like this:
- Authorise the network to automatically execute trades in your broker account
- You select the traders you would like to follow, and have their trades copied onto your account
- The trades will be executed in your account, and it is up to you to manage the risk limits. This, as we will discuss later on, is the real key to social trading: risk management.
- Be aware of “high frequency” traders, because their performance will be especially dependant on the spread they receive from their broker. If you have a different broker or higher spreads, your performance could be quite different.
- Be aware of the typical “slippage” that happens when a trade is copied. There will always be a slight difference between the price at which the master account executes, and the price at which the copied trade is executed. This is due to unavoidable latency (the time it takes for the signal to get copied onto your account), which is very low in any case. The only case where this could potentially result in very different prices is if the master trader executes during important news events.
- While it is not necessary to have prior trading experience when entering the social trading arena, it is still necessary to use common sense when evaluating, selecting and allocating risk capital to traders.
- Social Trading is not a panacea, so treat it as a high risk/high reward investment. Give it time to work for you. There are some professional traders who work very hard to produce results for clients, but they can have losing streaks and drawdowns as well. Evaluate their performance after at least a few months, not a few days.
Why Are Traders Using Social Trading Signals?
- It's efficient. Instead of being a foot soldier, trading each day away, you can be the “General” making strategic considerations. In particular, based on your own objectives, you can decide which traders to allocate capital to. The important thing is not to put all your eggs in one basket. That way, you can have multiple strategies working for you at the same time.
- It's perfect if you want to follow the markets alongside your day job. Since you don't have to place the trades yourself, you don't need to be at the screens every hour of the day. Your position is more like that of a portfolio manager or risk manager.
- It's a good risk management tool. Whether you trade on your own or not, this still holds true. If you trade your own strategy, then social trading allows you to diversify. So when the market is not reacting well for your strategy, it might be working well for some of your social traders. This will have a positive impact on your drawdowns and equity curve.
- Low entry barriers. Traditional hedge funds or CTAs have higher fees and stronger regulation. Social trading is a flexible, low-cost alternative to pure alpha strategies.
- Capital protection. Your risk capital in your trading account remains in your name, so you do not need to give anybody power of attorney. You remain in control of your account at all times. You decide how much capital to allocate to each strategy, and how much leverage to use. Also, you can step in and modify stop losses and targets if necessary.
- Scalability. If you are a successful trader and you want to attract more Assets Under Management, become a signal provider for a social trading platform. You generally have the possibility to ask for a subscription fee or a performance fee.
- Alternative to Expert Advisors. Many automated trading systems fail to adapt to the ever evolving market conditions. By selecting “manual” social traders to have in your portfolio, you can have the benefit of trades being executed ‘automatically’ on your account, secure in the knowledge that there is a human overseeing things.
How to Select a Social Signal Provider
- If something looks too good to be true, it probably is. Be dubious of signal providers showing 280% return on capital in 3 months. Most likely they are overleveraging the account or using a martingale money management system. Eventually, it will implode.
- Stay away from signals boasting 20-30% returns per month, which also have equal or higher drawdown. What you want to see is steady, consistent performance, not volatile performance.
- Seek signal providers using ‘real’ accounts. You want to know that the trader's money is on the line, and their interests are aligned with yours.
- Seek signal providers that have a long track record. You don't want to invest in a fresh signal provider with only a couple of months' history. You want a trader who has been through many different market conditions. A track record of at least one year and 100 trades or more is a useful start for evaluation.
- Be prepared to pay for performance. It's only natural that the best performers will want to be compensated for what they do. And if they help you grow your capital, it's only equitable. Even if there is a slight markup (i.e. increased spreads), that compensation is in a totally different ballpark relative to traditional fund manager fees. And once again, the fact that Social Trading is easily accessible (whereas traditional funds are almost exclusively for HNW individuals) is an enormous benefit.
- Seek signal providers with a professional background. Check their profile to see what they have done, and if they have a good pedigree.
Social Trading Risk Management
This is potentially the most important part of all. Social Trading is no golden ticket. One common error is to spend hours looking for “the best” signal provider, and then allocate 100% of your trading capital to them and raise the leverage. This is a recipe for disaster.
Instead, you should look to diversify amongst a small number of good providers who use different strategies. That way, your risk is effectively diversified. Another good practice is to allocate less funding to signal providers that have higher drawdowns, and allocate more to those with lower drawdowns, hence creating a sort of balance in the portfolio.
You will always have the ability to set risk limits on your account, so it might be a good idea to treat each signal provider like a single trade, to which you allocate only a portion of your risk capital and apply maximum loss limits (after which you will “cut” the provider). A good limit is a 20% drawdown.
One of the good things about Social Traders is that you can always reach out to them to discuss or ask about particular performance issues.
Finally, in order to keep your allocation in balance amongst your signal providers, remember to rebalance at regular intervals (monthly usually). Rebalancing is quite simple. If you have a profit from Trader A, and a loss from Trader B, then you take some of the profits from A and allocate them to Trader B to bring things back into balance.
Which Social Trading Platform is For You?
There are many Social Trading platforms available. Here we shall list two examples, which have very different objectives. Zulutrade base its business model on accessibility. It’s very easy to get started and there are no barriers to entry. SignalTrader tries to filter its providers, and thus has higher entry barriers.
ZuluTrade - http://www.zulutrade.com/
The main advantage of Zulutrade is that the platform is accessible to everyone. There’s also a free fully functioning demo (http://www.zulutrade.com/signup-demo) and you can create, verify and test a portfolio of signal providers. The negative side to so much freedom is that it takes a fair amount of common sense to sift through the signal providers and find the real performers. Fortunately, you also have a search engine that allows you to filter certain criteria. Typically, you would want to refine your search to long-standing traders (over 12 months of trading) and a low drawdown.
ZuluTrade Filter Page
To protect clients from poor use of leverage or excessive risk, ZuluTrade has introduced a maximum loss level you can set up for each signal provider. The feature is called ZuluGuard™ Capital protection.
SignalTrader – Signaltrader.com
SignalTrader is quite different from Zulutrade. There are far fewer signal providers, any they have been individually selected and verified. Because the quality of signal providers is higher, the capital requirements to subscribe to the signals are also higher: you need at least $5,000 in your trading account. You can connect with an account in a different currency, too.
All traders listed on SignalTrader also need to go through an evaluation process: they need to have exhibited positive returns and careful risk management (<15% drawdown) over the lifetime of their account. Since there are a limited number of traders available to choose from, there is no search functionality needed.
Over to You
If you have time constraints, or are looking to diversify a part of your risk capital, then take the plunge and go social!
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