Social Trading: No Two Traders are Alike
Social trading is a concept where less experienced traders can copy the trades of more experienced traders, usually within the confines of a social network. Social trading is lucrative for both the brokers who own the platforms and the traders (Leaders) who provide trade alerts to new traders that follow them (Followers). This makes it an attractive proposition to offer social trade alerts as a Leader.
While social trading has attracted some suitable talent among the pool of Leader traders, it has undoubtedly attracted many traders into this pool who can be classified as bad traders. Due to the fact that the social trading network/platform owners do not participate in the Leader selection process, the onus of selecting traders to follow falls squarely on the Follower.
It is needless to say that if a bad trader is selected as a Leader to follow, the end result will be a monumental disaster.
This is why as part of the skills that a Follower should have prior to joining a social trading platform, the ability to use performance metrics to evaluate Leaders and spot the bad traders among them is absolutely vital. Let us now delve into the core aspects of recognizing bad traders on a social trading platform.
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Who Are the Bad Traders?
Who is a bad forex trader? A bad trader is one who:
- Assumes too much risk in the market and does not appropriately apportion the capital in the account according to internationally accepted risk management standards.
- Does not analyze trades before making them.
- Pays no attention to correct position sizing.
- Has a large percentage drawdown. What does this mean? The simplest definition of a Drawdown is a decline of trading capital that is incurred after a succession of losing trades. All traders will experience drawdowns. The bad ones experience massive drawdowns because they do not control their risk. This causes their capital to drop radically once a sequence of losses hits their accounts.
- Uses excessive leverage.
- Has bad trade management techniques, or lacks any form of technique of trade management.
How to Recognize the Bad Social Traders
No bad trader will ever wear a toga that says: “hey guys, I am a bad trader”. Despite the social interaction that goes on in a social trading platform, there is still a degree of distance between the Leader trader and the Follower. The only thing that can point out a Leader as a bad trade is the trade performance metrics. Every social trading platform is supposed to have these performance metrics placed against the profile of every trader. Some platforms do not have enough information to form good metrics, but many of them do, and also add new metrics in response to demand from Followers. These metrics are what can be used to determine who the bad traders on a platform are.
So how can we recognize the bad traders using these performance metrics? A guide is provided below.
- Profitability Factor: This is without a doubt, the first thing you should look at. Any trader that is not profitable is a bad trader. You are in forex trading or binary options trading to make profit. Any trader that is either not making profit, or not making enough of it, or made profit previously but has started to fall away is not worth following. It is as simple as that.
- Profitability over the Last Year: It is possible for a Leader to be listed as profitable according to the profitability factor, and still be classified as a bad trader on the strength of this metric. There is a reason for using the last one year as a benchmark. Consistency is the trader attribute being tested here. You want to know if there is a history of consistency in profitability with the trader to be selected for following. You cannot afford to use traders who have a “start-stop” pattern: profiting for one month, losing for three months, and profiting again for one month, etc. Such inconsistency is like making a step forward, then two steps backwards and after a year, finding out that no progress has actually been made. You need someone who has been consistently making profits, month in, month out over a long period. One year is enough time to make such an evaluation.
- Profitability over a 7-day period: This performance metric gives the trader an idea about the aggression level of the trader. Some traders have exceedingly high rate of profit over a 7-day period, which provides a false sense of security to intending Followers. A certain social trading platform features trades with more than 900% returns over 7 days. While this may seem amazing, it is actually a warning sign that such traders may be using too much risk in trading. This metric must therefore be compared with the one above (profitability over one year) as well as the following metric.
- Risk Score: Several social trading platforms have started developing risk scores for each trader on the Leaderboard. The risk score is a calculated score which measures the impact of a Leader’s risk on a trader’s account. The higher the risk score, the greater the risk applied to a Follower’s account. Some social trading network providers have settings which block Leaders with high risk scores from being able to offer trade alert services on their platforms. Then there are traders whose risk scores are teetering on the borderlines of being blocked as a result of high risk. Traders who use too much risk are bad traders, because they will end up with large account draw downs when they encounter losses.
When you encounter Leaders with these performance metrics, they constitute bad traders and should not be followed on social trading platforms. If you are patient enough to compare the trades of these bad traders with the good ones over a period of time, you will discover that the bad traders do not stand the test of time. These are things which have been tested and found to hold true across social trading platforms.
Bad traders may actually do well short term, but they do not last. As a social trader looking for a Leader to follow, it is better to follow the good traders from the onset so as to imbibe their trading culture from the get-go. Following bad traders who are transiently successful has the tendency to implant bad trading methods and mindsets that will be hard to unlearn.
So do things the right way; recognize the bad traders in a social trading network and choose not to follow them.