Social Trading: what exactly are we talking about?
Social commerce is all the rage. Many platforms offer this type of service (eToro, Admiral Markets XTB, etc.). Or rather these services, because social trading comes in different variants: trading signals, copy trading, mirror trading. However, the risks are very high and the long-term gains ultimately turn out to be weak or even non-existent. We explain why.
The different forms of social trading
We can understand individuals’ interest in social trading: easy to set up, achievements that make you dream, a pool of thousands of traders to copy… There are different forms of social trading:
- Trading signals: sent through a Telegram channel, with indications about the orders to be placed on an asset,
- “Packaged” products: portfolios of previously selected assets, which can be copied freely or automatically as with controlled life insurance,
- Copy trading: fully automated, reproducing all the trades of the copied trader in your portfolio, respecting the capital scales.
The risks of social trading
Of the forms of social trading, copy trading is unsurprisingly the most risky.
The risk factors are:
- Copy trading is not regulated by the AMF
- Poorly structured or even non-existent risk management
- Opposing objectives between broker and client
Copy trading is not regulated by the AMF
This is the whole paradox of social trading, which is not considered investment advice. However, authorizing a trader to automatically place orders on your account is portfolio management.
In normal times, investment advice and asset management are closely supervised. You must have a CIF (Financial Investment Advisor) license to engage in these activities:
- As part of a life insurance management mandate
- On a trading site
The lack of regulation of copy trading opens the door to many excesses. It is therefore surprising to see that the AMF is not stricter on copy trading services, if the aim is to protect clients from the actions of brokers. Many merchants cause their copiers to lose money, but there is currently no cure. Especially since most of the brokers that offer this service are regulated in Cyprus.
Poorly structured or even non-existent risk management
The problem with copy trading comes from the performance escalation. If a trader wants to attract the maximum number of copiers, he needs to be very high performing and as attractive as possible. However, performance is never without risk. And novice traders are rarely interested in a trader posting +20% for the year…
To maintain its stock of copiers, the trader must continue to take risks:
- By increasing its leverage
- By increasing the size of its positions
- By trading the most volatile assets
So yes, the trader will put in a +500% performance for the year, but at the cost of very poorly constructed risk management – which has even been downright forgotten. Behind traders who post +500% during the year, we often see a draw
more than 70% (withdrawal = maximum loss incurred, a withdrawal of 70% indicates that the account has lost 70% of its capital at some point).
These traders will make you money for 1 or 2 months, yes. But eventually, at some point or another, they will bring your account back to zero. This is the reason why copy trading mainly remains a (very) temporary process. Trustworthy reviews on eToro (the leader in social trading) make it clear: copy trading cannot be an end in itself.
Opposing objectives between broker and client
The real copy trading winners are signal brokers and traders. The copied traders are compensated based on the order volumes they generate through their subscribers. The more copiers they have, the more likely they are to earn
the money! The broker is rewarded by trading commissions. If an expert trader multiplies order volumes thanks to his subscriber base, so much the better. And if traders use leverage, even better. In the end, the customer turns out to be the only loser. It is he who pays the commissions, it is his capital that is trimmed by the losses…
Conclusion
In the medium term, copying a trader will not make you a winning trader. As we’ve seen, the dice are slightly stacked against the customer, leaving behind them different lengths. If you want to make money in the financial markets in the long run, invest in yourself. Training, money management, a good trading strategy… Trading socially, through trading signals and copy trading, are only temporary and risky steps.
Financial Markets / Risk Warning : Investing involves risks. By investing in the financial markets, you may lose all or part of your capital. We recommend that you only invest in financial products that match your knowledge and experience. Past performance does not prejudge future performance, is not constant over time, and is in no way a guarantee of future performance or capital.