What is Social Trading?
Social and Copy trading, first came onto the investment scene back in 2008 and it has been the Forex industry who has fully embraced the concept. Proponents of copy trading state that it has the ability to revolutionise how people will invest their money and that it will come to replace more formal forms of investment in the future. While this remains to be seen, there are increasing number of people investing and making money with social trading networks. As the quality of these platforms improve there are only going to be more opportunities for those interested in investing capital in social and copy trading.
The fundamental idea behind copy trading is that those without the necessary experience and ability to trade the markets successfully for themselves, can still make money by simply following those who do. Social trading networks aim to connect successful traders with potential investors. Rather than trade for themselves the potential investors simply copy these successful traders. While the actual workings vary from network to network, those sharing their trades with other users are typically rewarded commission for bringing customers to the brokerage or service. If these traders are successful they can build up large following which allow them to earn a significant second income. This gives those traders a real reason to share their trading strategies as they can earn a significant side income, which can very nicely supplement their trading income.
While social trading presents an amazing opportunity for investors it is not simply a license to print money. Traders using these services are thrown into a role which sees them responsible for selecting which traders to copy. While social trading platforms typically rank users of the service in regards to how well their strategies have performed in the past these rankings have been notoriously unreliable. Ultimately, investors will be required to become a quasi fund manager and will have to identify which traders represent a good long term investment prospect.
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Identifying the right traders
So what factors should investors use to determine which traders to copy? We aim to outline some of the factors that investors should take into account when picking which traders must take consideration of when choosing traders to follow.
Max Drawdown is quoted as a percentage figure and can be useful for determining the risk of a traders strategy. If a trader had $200,000 in their account and then lost half this amount, their account would this would have been 50% drawdown. Max Drawdown is a historic represents the largest continued loss a trader had ever experienced. This is important as a historically large drawdown can suggest that a trader hasn’t been properly managing risk and may not represent a sound investment choice.
Equity Curve the vast majority of social trading networks will show you a traders equity curve. Namely historic levels of equity will be displayed as a line chart. Accounts which demonstrate wild fluctuations but an overall upward trend suggest that a trader may be using an erratic strategy. What investors should look for is a trader who has consistent upward trend with limited peaks and troughs, this suggests steady and consistent returns.
Win Percentage while a useful metric it is not to be overvalued. Winning percentage just states the percentage of trades one by a particular trader. If a traders money management is bad a win percentage can have little meaning, as a small number of big losses can chip into a traders profits.
Trade by Trade Analysis, very serious investors may want to download the full history of a trader in order to better evaluate his strategy and style. Traders should look for trades which resulted in big losses and whether the trader has a tendency to hang onto to positions for too long etc. This can help identify traders who are operating without proper risk management. Unfortunately, not all social trading networks allow you full access to traders historic data which limits the extent of analysis which can be undertaken.
In addition to selecting the correct traders to follow, it is recommended that investors customise their risk preferences with the majority of social trading networks providing traders with risk management settings. There are no hard and fast rules regarding how a trader should manage his risk and such settings will largely depend on an individuals risk appetite. Traders would be recommended in placing some overrides on the actions of those they copy, with it useful to set custom stop losses and prevent traders from opening an ever increasing number of trades in the hope of clawing back losses.
Social trading presents a great opportunity for investors looking for a new way to invest their money. As with all forms of investment there are significant risks involved but traders can minimize these risks by carefully selecting which traders to copy. Additionally traders should spend time customizing their risk settings to bring their risk in-line with their overall risk appetite. If traders are willing to do this, social trading represents a unique opportunity and one with the potential to deliver some truly impressive returns.
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