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Is social trading all it’s cracked up to be?

social trading

The other day I came across an article at Finance Magnates which encourages brokers to add social trading to their product offering. It offers up ten reasons:

  1. Social trading brings a new age of transparency.
  2. Social trading improves customer relations by creating a more confident trader that is happy trading with your brokerage.
  3. Social trading can be an essential marketing tool that seeks to blast through the acquisition barriers to entry, while at the same time bolstering client retention.
  4. Social trading entices users to convert themselves into traders simply by following and copying already established traders in a broker’s social community.
  5. Social trading helps a broker boost their acquisition and deposits by giving a novice trader who is nervous about losing his money, the notion of being able to copy from already established traders with a proven track record, thus quelling his fear of a first deposit.
  6. Social trading helps brokers lower their attrition rates and in turn boost retention by giving traders an FX community they can feel a part of. Once a trader finds his place in a network and begins following and copying a master, he would prefer to stay with your brokerage and not forfeit what he has already accomplished.
  7. Social trading helps a broker increase their trading activity. When a master trader opens a position in a social trading community, all those traders copying him will open the exact same position at virtually the exact same time.
  8. Social trading networks that are seamlessly integrated into a broker’s trading platform tend to increase the amount of time a trader spends inside the platform, thus increasing trading activity and retention.
  9. Social trading gives traders the ability to trade even when they are asleep. A broker may see his traders being active even during their downtime if they are following a master who may be trading in a different time zone, and is therefore active.
  10. Social trading makes newbie traders more comfortable because the experience is more social and less intimidating.

Obviously, this piece was targeted at the business side of retail forex. Many of the points made relate to gaining and keeping brokerage customers. In fact, at the end of the article the following justification is made:

When implemented correctly, social trading can boost the lifetime of the average trader by 14% or nearly a full month, increase trading activity by more than 50%, increase net deposits by 32% and a broker’s P&L by 40%, thus raising the value of each trader significantly.

I don’t know where those numbers come from as there aren’t any citations included.

I’d actually like to look at things from the trader’s point of view, though. I did a fair amount of work with Currensee, which was the first forex trader social network and one of the early social (copy) trading platforms (they were eventually bought by OANDA, then later shut down). As a result, I got to learn about some of the downsides of social trading. I also recently completed a PhD focusing on trader performance, so I have an idea of the sorts of issues that can arise in this kind of structure.

That’s why I have some problems with #1. Transparency isn’t necessarily all that great. There are signs that sharing one’s trading with others can actually result in worse returns. In fact, at Currensee one of the original Trade Leaders (as they were called) totally blew up once they brought him in to the program. Basically, he couldn’t handle it psychologically. Once they dropped him, though, he went right back to being profitable.

And related to #10, one of the things I heard from the Currensee folks is that traders were messing around with the social trades being done in their accounts. Specifically, they were closing them early, to their detriment.

On top of all this, there is a lot of research into the poor track record of investors moving in and out of mutual funds. This is essentially the same idea as being able to change which traders one accepts social trades from, so that’s another pitfall.

Oh, and as to #9, many traders already have that sort of access. They do so by using Expert Advisers (EAs) and the like to trade automatically.

I’m not saying social trading can’t be beneficial. I’m just saying it needs to be given a lot of thought and consideration.