Performance and Ranking in Social Trading

Social trading has taken off in a big way over the past few years and many industry experts are convinced that in the not too distant future almost every retail trading platform will incorporate ‘social’ functionality. Social trading can be broken down into two main categories of features:

  • Trading social network
  • Copy trading

The social network side of social trading platforms is an environment in which traders can share content, opinion and discuss themes of interest. It will often be broken down by securities or topics such as aspects of technical analysis in much the same way as a forum. Newsfeeds of crowd-generated or recommended content and the opportunity to discuss problems or concepts with other traders is central to most social trading platforms.

Copy trading, meanwhile, is the core functionality of social trading. The way copy trading works is that the trading history of every trader taking positions through the platform is publicly available. Traders are also ranked based on their history of success, with heavier weighting usually given to more recent history in a leaderboard format.

Every trader on a social trading platform can ‘copy trade’ or ‘mirror trade’ any another trader. This means, depending on settings selected, an individual trading position, or every trading position, of that trader is automatically copied in the trading account of the copy trader. The value of the trade can usually be set lower or higher, and a copy trade stop loss is usually available which can differ from that of the copied trader, but the basic position will be the same.

There are several advantages to copy trading on a social trading platform:

  • Beginner and less experienced traders can take advantage of the knowledge of more experienced/successful peers.
  • Seeing how good traders trade is a very useful educational process.
  • Risk can be diversified both away from a trader’s own trading and between several other good traders. This might mean a much wider diversity of different positions. It could also mean entirely different securities or asset classes that the copy trader is not familiar enough with to trade themselves.
  • Successful traders who attract ‘copy traders’ are usually awarded a % of the social trading platform’s spread for every trade their followers make. The copy trades are considered as capital under management of the copied trader.

 

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Choosing Traders to Copy Trade: Performance & Ranking

Key to successful copy trading on social trading platforms is of course making the right choices when it comes to the selection of other traders to copy. Social trading platforms always have leaderboards and ranking systems designed to rate the platform’s most successful traders. The natural assumption might be to simply choose to copy the several traders at the top of the platform’s leaderboard. However, to stand the best chance of realising a successful copy trading strategy, a more sophisticated approach should be taken.

Leaderboard rankings on social trading platforms work in slightly different ways but will almost always assign a score to traders comprised of a number of elements. The weightings given to these elements will vary to an extent but tend to include overall portfolio performance over different periods of time, from a week to the past year or even longer. Trading frequency, number of followers and copiers are also usually factored in.

 

The Dangers of Ranking Bias in Social Trading

The issue with choosing traders to copy purely on the basis of their position in the platform’s trader ranking table is that, like any form of investment, past performance does not guarantee future results. This is especially the case when it comes to trading. Approaches and strategies that appear to be working well over a period of time can relatively quickly stop producing results as market conditions evolve.

That is not to say that the top ranked traders are not likely to be very competent traders. However, it is to say that there is a risk highly ranked traders may not be as competent as their current ranking suggests.

 

A winning streak over a few months and an active social profile could quickly gather enough followers and copiers to propel a trader into a high leaderboard position. However, longer term that might prove to be a false impression of the trader’s real level of expertise.

 

It is important to understand how the ranking system works on the social trading platform you are using and assess in more detail the trading record of top ranked traders. How much has their number of followers and copiers, rather than actual trading record, contributed to rank and over what period of time have profits been consistently returned?

 

How to Choose a Social Trader to Copy Trade

Rankings in the trader leaderboard on a social trading platform is a good place to start when looking for the right traders to copy trade but should not by any means be the only thing to look for. The following indicators should all be assessed:

Longevity of Consistency: over how many months has the trader consistently managed to achieve returns? A stellar 3-month period should not be enough to convince you a trader is worth copying. Market conditions, which change over time, may have been perfect for the trader’s strategy and luck can also play a major role over shorter timeframes. A trader who has shown healthy, though not spectacular, returns over more than six months is a safer bet than one who has realised great returns over a few months.

Securities Traded: how many different securities are traded by a successful trader is also important to assess. If they are able to generate strong returns from a wide range of different securities across asset classes, this suggests trading expertise that can be relied upon. It also means that if this trader is copy traded, risk management is improved through diversification. Choosing traders to copy who trade more or different securities to yourself, especially those with little or inverse correlation, will mean your portfolio is less exposed to unexpected conditions in a particular market. Greater diversity in an investment portfolio means good risk management and in the long run this has been demonstrated to improve long term results.

Understand their Reasoning: it completely makes sense to copy traders whose strategy you understand. If you can’t see the reasoning behind a particular position then it is best to avoid copying it. You can of course always ask a trader being followed to explain the analysis that has led them to a position. Understanding how a trader arrives at decisions significantly reduces the risk of copying someone on little more than a lucky streak. It also helps develop the copy trader’s own ability to analyse and pick out positions to take.

Copy Several Traders: as well as giving priority to traders whose reasoning is clearly understandable, have a longer track record of consistency and who trade a healthy range of securities, another mechanism to avoid copy trading mistakes is to always copy several other traders simultaneously. Even the best traders have losing streaks and by spreading capital between several, your own returns will not be too badly impacted when 1 trader being copied has a rough patch.

 

Conclusion

Take the time to properly assess traders with good rankings to find those that it will be best for you to copy trade. The top of the leaderboard is a good place to start but make sure traders whose skill you will entrust your own capital to meet the conditions mentioned above. Copy trading the 10th best ranked trader could well prove to be a better decision in the long term than automatically going for the top ranked.