The Concept of Social Trading

Institutional trading firms record a high level of success in the market, whereas 95% of individual traders do not. Why is this so? It is because there is strength in numbers. Trading is an activity that benefits from having an input of ideas and skills from several persons to arrive at a course of action. In an institutional trading setup, there are Junior Traders, Mid-level Traders, Advanced traders, and a Chief Trader. The hierarchy clearly defines who has more skill, and those on top of the trading pyramid provide advice, mentoring and oversight to those below. This all comes together to ensure positive trading outcomes.

In order to mimic the institutional trading setup, social trading networks were developed to bring together experienced traders with not-so-experienced ones. By allowing the experienced traders share their knowledge of forex trading/binary options trading with others, they can provide the support system that junior traders within the networks need to succeed in the markets.

This system, which also provides accountability for all parties concerned, is the basis for modern-day social trading networks.

 

Table of Cotents

 

How Social Trading Works

First, we have three levels of participants in a social trading network.

  1. The Leaders/Signal Providers
  2. The Followers/End-Users
  3. Social network providers

The Leaders/signal providers are the experienced traders who give out trade calls and mentoring, and get paid for it by the end-users. They are paid from subscription fees they charge, or they may be paid from a portion of spreads generated from the trades of their subscribers. So for the Leaders, it is a game of numbers. The greater the number of traders that use their services, the more money they make. All Leaders are required to disclose details of their trades. This is to enable the social network providers show case REAL trading results which can be used as a performance evaluation metric.

The end-user traders, also called the Followers, are inexperienced traders who depend on the trade calls of the successful leaders to make a profit from the market. They pay for these services, either by paying a subscription fee or by being charged on the spreads of the trades they make. They may end up paying higher spreads to offset this cost. They may also pay from a portion of whatever profits they make (the most desirable option as payment is performance-based).

Social trading networks provide a transparent and safe environment for both Leaders and Followers, ensuring no one is cheated in the process. They provide the system which presents Leader performance metrics such as profitability over time, draw-down percentage, a performance graph, etc. However to avoid conflicts of interests as well as litigation, social network providers do not provide advice to Followers on how to select Leaders.

 

The Business Social Trading: Models Operational in the Markets

So now that we know what social trading is all about, the next step is to understand how social trading is offered to the end users within the context of the Forex trading and binary options trading platforms of today.

 

 

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Who Offers Social Trading?

Social trading is offered in two ways:

  1. It can be offered by forex or binary options brokers themselves.
  2. It can also be offered by independent providers. These are the companies which drove the social trading innovation when it first started in 2006. These independent social trading providers usually work with a single broker or a range of brokers on whose platforms the social trading concept is offered.

 

Do Users Pay for the Service? If So, How are Payments Charged?

The model offered to the end user determines how the users are charged for the service, or how the providers are compensated for the service. When end-user traders get free access to the social trading providers, it is not usually free in the real sense of the word. The spreads generated by the trader are shared between the broker and the provider. Sometimes, spreads may be a bit higher than what is obtainable on other platforms to cover this cost.

When a user has to pay directly for participation in a social trading network, then this is usually on a subscription basis. Here the providers of the social trading network will charge both the ens-user traders and the Leaders providing trade alerts and mentoring services a fee. Users can also expect to pay both for using the service, and also make payments to the Leaders whose trades they follow.

 

 

 

Is Social Trading Regulated?

This is one of the questions many users ask when wanting to join a social trading network. Social trading does not work in isolation: it is still considered a financial product. Where brokers provide the social trading service, it is straightforward as brokers are expected to be regulated. Regulation and licensing of brokers usually covers the financial products that they offer within the context of forex trading or binary options trading.

It gets a bit more nebulous when independent providers are offering this service. In many countries, financial market regulators have varying definitions of social trading as a financial product, as well as different rules regarding the nomenclature and licensing of companies that offer social trading services.

So what do regulators have to say about social trading?

US – The CFTC in the US has various licenses it provides to different categories of companies and individuals working in the financial markets. All entities must be regulated with a specific license category: brokers, dealers, portfolio managers, investment advisors, etc. Technically speaking, providing a service such as what Leaders do in a social network is akin to investment advice: such individuals must be licensed. There is also the FIFO (first in, first out) rule to consider. The FIFO rule prohibits hedging. So while social trading is not prohibited, the rules define that some level of licensing is required for signals providers and for the social trading networks offering the platforms for these services.

UK – In the UK, social trading is classified as a form of portfolio management. Social trading networks must be licensed as portfolio managers. The situation in the UK is different from that of the US in that the signals providers do not have to be licensed to provide trade alerts and mentoring on the social trading networks.

Europe – Rules regarding social trading in Europe are similar to what obtains in the UK. It is presently unknown how Brexit will affect these rules.

Japan – Despite the closed nature of its markets, latest data and reports indicate that social trading is on the increase in Japan. The regulators there do not seem to mind about the status of social signals providers or the social trading networks. However, all trades must be executed only on JFSA and FFAJ-licensed platforms.

Australia – ASIC only requires social trading network providers to display the earnings disclaimers on their websites conspicuously.

 

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