Social Trading: what exactly are we talking about?
Social trading is all the rage. Many platforms offer this type of service (eToro, Admiral Markets XTB, etc.). Or rather these services, because social trading can be found in various 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 the interest of individuals for social trading: easy to set up, performances that make you dream, a pool of thousands of traders to copy… There are several forms of social trading:
- Trading signals: transmitted via a Telegram channel, with indications on the orders to be placed on an asset,
- “Packaged” products: portfolios of previously selected assets, which can be copied freely or automatically as in controlled life insurance,
- Copy trading: fully automated, where all the trades taken by the copied trader will be reproduced in your portfolio, respecting the capital scales.
The risks of social trading
Among the forms of social trading, copy trading is unsurprisingly the riskiest form.
The risk factors are:
- Copy trading is not regulated by the AMF
- Poorly constructed or even non-existent risk management
- Opposite 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, giving authorization to a trader to place orders on your account automatically is portfolio management.
In normal times, investment advice and portfolio management are strictly supervised. You must hold a CIF (Financial Investment Advisor) license to be authorized to practice 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 abuses. It is therefore surprising to note that the AMF is not stricter towards copy trading services, if its objective is to protect clients against the actions of brokers. Many traders are causing their copiers to lose money, but no remedy exists at this time. Especially since the majority of brokers offering this service are regulated in Cyprus.
Poorly constructed 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 must show very high performance and the most enticing possible. However, performance is never without taking risks. And novice traders are rarely interested in a trader who posts +20% for the year…
To maintain his base 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 post a performance of +500% for the year, but at the cost of very poorly constructed risk management – even downright relegated to oblivion. Behind traders who post +500% over the year, we often observe a drawdown
exceeding 70% (drawdown = maximum loss suffered, a drawdown of 70% indicates that at some point the account has lost 70% of the capital).
These traders will make you money for 1 or 2 months, yes. But they end up bringing your account down to zero at some point or another. This is the reason why copy trading remains above all a (very) temporary process. Reliable reviews on eToro (the leader in social trading) make it clear: copy trading cannot be an end in itself.
Opposite objectives between broker and client
The real winners of copy trading are signal brokers and traders. The copied traders are compensated 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 remunerated 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 which is trimmed by the losses…
In the medium term, copying a trader will not make you a winning trader. As we have seen, the dice are somewhat stacked against the customer, who leaves several lengths behind. If you want to earn money on the financial markets in the long term, invest in yourself. Training, money management, a good trading strategy… Social trading, through trading signals and copy trading, are only temporary and risky steps.
Financial markets / Risk warning : Investing involves risk. By investing in the financial markets, you may lose all or part of your capital. We recommend that you invest only in financial products that match your knowledge and experience. Past performances do not prejudge future performances, they are not constant over time and in no way constitute a guarantee of future performance or capital.