It has often been said that birds of a feather flock together. This timeless maxim is actually just as relevant when discussing the latest investing trends. Thanks in large part to the ubiquitous nature of the Internet, we have recently witnessed a rise in a practice known as social trading.
As you might have already concluded, social trading simply involves the act of following the advice of specific online communities and/or influencers. Although this approach might initially appear to add another “string to the bow” in terms of trading opportunities, is it really that sound of a strategy?
There is no single way to answer this question. We will instead have to delve into a handful of underlying principles before moving on to weigh the pros and the cons. You can then decide if social trading is the best solution for your investment needs.
When Did Social Trading Begin to Emerge?
It is wise to quickly examine the roots of social trading, as these can be used to better appreciate where the entire online investing community may be headed. While there is no definitive date associated with the birth of this movement, most experts agree that its roots can be traced back to the online chat forums of the 1990s that preceded social media platforms.
It did not take long for major investment firms to notice the potential. Virtual brokerages such as eToro began including social signals within their interfaces as far back as 2007. It would not be long before other companies followed this example. Social trading is now becoming one of the core tenets of online investing.
What is the Appeal of Social Trading?
Now that we can appreciate the pragmatic foundations of social trading, why has it become such a popular tool offered by countless online trading brokers? One primary reason involves the ability to cater to a new generation of investors. We need to remember that younger traders have already become fully immersed within communities such as Facebook, X (formerly Twitter), Instagram, and WhatsApp. They are familiar with the associated mechanics, and they will often turn to these sources when seeking advice.
Indeed, a recent study found that more than 30% of investors born after the 1980s will now (at least partially) rely on social feeds to make financial decisions. When taken at face value, here are some motivating factors:
- Real-time information can be accessed with the click of a button.
- A significant number of social trading platforms can be downloaded as dedicated apps; providing constant connectivity.
- Many feel that social trading signals are excellent ways for novices to learn the basics.
- It has also been claimed that social trading can reduce emotional bias (important when making objective decisions).
Note that we are not only referring to investments in this case. Whether discussing secured loans, second mortgages, or evaluating different retirement packages, social connectivity now represents an important facet of the overall decision-making process.
We are nonetheless forced to ask another relevant question. Are the observations outlined above realistic, or do they represent nothing more than the latest round of “smoke and mirrors” that can sometimes provide a false sense of security? Let’s now play the devil’s advocate, and examine the other side of the proverbial coin.
Social Trading: Real-World Applications, or the Stuff of Fantasy?
Let us now take a step back, and analyse the big picture. Some self-proclaimed investment gurus claim that social trading is set to transform the entire digital investment community. This is when things become more than a bit murky. Any promises about a sure-fire solution should always be taken with a grain of salt. Social trading is certainly no different in this sense.
For instance, nearly half of all novice investors have stated that they made at least one bad decision based on advice obtained through social channels. Furthermore, only 11% of those with more than ten years of experience turn to these sources of information when formulating a trading strategy.
To put this another way, it seems that social trading is primarily leveraged by those who have yet to develop sound techniques. This is why it is equally logical to highlight some potential pitfalls that could result from an overreliance on social trading:
- Not all signals are correct.
- Well-known traders may have an undue influence on particular markets.
- Some investors may not possess the expertise that they claim.
- Even seasoned experts can be wrong on occasion.
Another hazard that cannot be overstated involves a concept known as copy trading. The theory here is relatively simple. A novice trader will mimic the actions taken by a more experienced investor; often with the help of social circles. The assumption is that this should ensure a healthy profit margin over time, even when incurring the occasional loss. However, a crucial caveat needs to be stressed.
Copy trading precludes the notion of a learning curve. In other words, investors are not actually acquiring new skill sets. They are simply pantomiming the actions taken by others. Many feel that this goes against the very fundamentals of trading. Knowledge is power, and those who follow others are not likely to hone their own strategies.
The Middle of the Road
So, might we be able to find any common ground between the two perspectives summarised above? Perhaps the main takeaway point is that social trading does indeed have its merits. However, this approach should be used in tandem with other proven techniques. This is also why any regulated Forex broker will offer social trading tools alongside a kaleidoscope of other instruments. To use an analogy, a bird can never take to the sky with a single feather. Flight is a result of many faculties working in combination with one another. This is the same with any type of astute investment strategy.
Keeping One Step Ahead
To be clear, it is nearly impossible to “beat the market”. Occasional losses will occur. Mistakes are inevitable. Social trading is an interesting concept, and when used in synergy with other approaches, its merits can rise to the surface. We ultimately need to remember that the most successful investors will never limit themselves to one technique. They will instead incorporate various processes into a much broader strategy. This is the best way to ensure a relatively stable return-on-investment, and to ensure that the learning curve never truly ends. It will nonetheless be interesting to see how social trading continues to evolve in the coming years.
