The Concept of Social Trading in Forex
Forex social trading came on stream sometime in 2006 when ZuluTrade pioneered the prototype of what would later be the social trading platforms. Since then, several innovations in this field have been carried out. One of these innovations was the development of a Forex copy trade system, which allowed inexperienced Forex traders to automatically copy trades of experienced traders. This added to the core social trading system where there was human interaction, mentorship and direction to explain the trades that were copied from the Leaders to the accounts of the Followers.
In the Forex market, there is a merger of both social trading and copy trading platforms. Some providers merge aspects of both platforms, while others separate them into different financial products. Two categories of companies offer this service. There are third party providers as well as Forex brokers.
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The Structure of Copy Trading in Forex
The copy trading system of forex has the following components:
- The Leaders: These are the experienced traders found on the Leaderboard within the system. Leaders supply the trades and expertise, as well as mentorship and explanation for their trade decisions on the social trading feeds. They also provide trading signals in copy trading platforms.
- The Followers: The Followers are the traders who copy the trades generated by the Leaders. The Followers are those who own the accounts that trades are copied to.
- The Social Trading Platform Providers: These are the companies that provide the social trading platforms. As identified previously, these companies could be independent third party providers or Forex brokers themselves.
How the Copy Trade System in Forex Works
Trades in forex are straightforward Buy/Sell trades, unlike the binary options market where there are different trade types. Although forex trades are split into market orders and pending orders, the predominant trade types used in the social trading platforms are of the Market Order variety.
The administrative interface comes with a front end and a back end.
There is a front end which provides the interface for Copied Traders to put up their profile and their accounts, so that their performance metrics can be compiled by the copy trade portal providers. This is also where Followers can search for the Leaders/Copied Traders, evaluate their statistics, add/remove funds, and also copy/add/remove traders.
Then there is the back end of the copy trade software. This is where the system harnesses and synchronizes the functions that replicate the trades of the chosen traders to the accounts of the followers. This section of the portal requires high level of coding competence and maintenance by experienced programmers.
How to Copy a Forex Trader
The following is a description of the steps required to copy a forex trader. The process is split into phases as follows:
- Platform selection
- Account Opening and Funding
- Leader Selection
- Capital Allocation
So what is involved in each of these steps?
To be able to copy a trader, you have to select the right platform. The right platform is one which features regulated and licensed brokers (for third party companies), or where the broker offering the platform is regulated. Furthermore, it is essential that the right performance stats are displayed. This helps the Follower make an informed Leader selection. Not all platforms can deliver on this point, so it pays to evaluate several social trading platforms to get a picture of the performance metrics set out for each Leader.
Account Opening and Funding
It should be easy to deposit funds to start copying a Leader. Several systems already exist to cater to this purpose.
Selection of Leaders
The selection of Leader traders to copy in the forex market is the most important aspect of the process. It is assumed that the trader has already selected a platform that has the right performance metrics with which traders on the Leaderboard can be evaluated. Some platforms have gone the extra mile to split the Leaderboard to display trending traders, recommended traders and traders that are about to fall off the Leaderboard. This helps, but does not replace the work the trader has to put in to select the right Leaders.
The most important metrics for Leader selection are as follows:
- Profitability Factor
- Drawdown %
- Risk Score
- Profitability over 7-days, 1 month, 6 months and one year.
The best traders to follow are those that present the following performance stats:
- Good profitability factor,
- A drawdown % of less than 20, and not more than 30%.
- For platforms that display this, a low risk score of between 2 and 4 on a scale 10, where 10 shows maximum risk. Some platforms will use a color-coding system of rating risk by showing red against a Leader with a risky strategy, amber for a mid-range and green for least degree of risk.
- Profitability over 7 days, 6 months and one year. There should be a consistency in the pattern of profitability. Traders with low profitability percentage over 6 months to 1 year, but who display high returns over a 7-day period are traders that use high risk strategies and unsteady performance.
- Some platforms display a performance graph over time. Traders with a gradual, rising slope are the best traders to follow. Spikes in the performance graph indicate inconsistency in trading techniques, leading to oscillations in performance.
Of course, you never want to copy traders who display a downward slope, indicating declining performance.
Once a trader has been selected for copying, the next step is to allocate a portion of your capital to that trader’s trades. Ideally, not more than 3% of your account capital should be used to copy traders. Not only is this in keeping with international standards of risk management, it also provides your account with the capacity to take on extra traders if the need arises. Once you have allocated the capital, you will be prompted to set a minimum capital level (from the allocated capital), below which the system will automatically stop copying that trader. Think of this as an internal stop loss within the allocated capital. Once you are set, you can execute the Copy trade function on your social trading platform.
You do not just select a Leader to follow and go to bed, even if the trades you are copying are profitable. You need to continuously follow-up on the traders you are copying, and also monitor the Leaderboard for other new traders that may be emerging. Constant tweaking to get the best results is the way to go.
There is no limit to the number of traders that can be copied on a social trading platform, provided you have sufficient capital to cover the trades. Ensure your accounts are well funded, and continuously monitor the performance of the traders you are following to ensure optimum returns.