Social Trading: A Collection of the Good, the Bad and the Ugly
Social trading is a concept that mimics the environment found in proprietary trading institutions and other institutional level traders. This environment provides a well-defined hierarchy of traders, starting from the junior traders to the very top guys in the trading world. But there is a difference: if you are an investor whose money is traded by institutional traders, you can just drop your money and go to sleep, because the firm has a process which can select the best traders to trade for you. But if you are in a social trading network, you are solely responsible for recognizing the good traders and selecting them. This can be a difficult proposition.
If there were no good traders, there would be no basis for a social trading network. The goats always graze where the grass is green. So there will always be green grass (good traders) to keep the pasture of social trading very much alive and bubbling.
This is why a Follower should be able to acquire the skills required to recognize and select the good traders located within a social trading platform. But before we get down to the selection metrics, let us know what the good traders are all about and their characteristics.
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Who Are the Good Traders?
Who is a good forex trader? A good trader is one who:
- Understands that risk management is the key to longevity in the market and applies solid risk management principles to their trading.
- Analyzes all trades properly using technical and fundamental analysis before entering these trades.
- Pays proper attention to correct position sizing.
- Keeps drawdowns as low as possible. Since all traders will experience drawdowns, it is essential to know how drawdowns tend to affect trades. A low drawdown level will ensure that there will be enough capital to recover from any season of losses.
- Does not use excessive leverage in trading.
- Is able to perform good trade management, which leads to long term success in the markets.
- Constantly strives to improve themselves to ensure they continue to remain on the Leaderboard on the social trading platforms.
How to Recognize the Good Social Traders
As mentioned earlier, the responsibility of selecting good traders to follow on social media platforms is 100% that of the Follower. The only way to know who the good traders are is to perform an evaluation of their trader metrics. Every social trading platform provides facilities to enable traders study these metrics. The trade performance metrics are usually found within the profile of the Leader traders.
So how can we recognize the good traders using these performance metrics? What follows below is not a hard and fast rule about good social trader selection, but it can act as a guide to build upon. These metrics are the same metrics that are used to pick out bad traders.
- Profitability Factor: A good trader is one that has a history of making profit. Therefore, the profitability factor of a trader should be in the green for that trader to make the cut. So good traders should be profitable traders. Making profit is what is required in forex trading.
- Profitability over the Last Year: The reason behind measuring profitability over a one year period is to enable the assessment of a Leader trader’s performance over a time that is considered long enough to be deemed consistent. Consistency is a key metric in the recognition of good traders. As a Follower, you need a Leader who delivers profits month after month, and not one that can deliver profits for just two months and thereafter hit a 4 month losing streak. Some social trading networks will feature profitability metrics over a 6-month period; this is still ok, but the longer the period under evaluation, the better.
- Profitability over a 7-day period: This performance metric gives the trader an idea about the aggression level of the trader. The ideal good trader should be one with a balanced pattern: not too aggressive as to jeopardize risk management, and not too conservative as to miss out on many trade opportunities. A good trader will ideally have a 7-day profitability factor that is somewhat a reflection of the 1-year profitability factor. Since most Followers on a social trading network are generally new to forex, the good traders are those whose returns in a 7-day period do not connote undue trading aggression.
- Risk Score: The Risk Score setting is a new metric gradually being applied across several social trading platforms. The risk score is a weighted calculation which shows the impact of a Leader’s risk management techniques on a Follower’s account. The higher the risk score of the Leader, the greater the risk to the 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. But even with those who are left behind, there are still the Leaders with risk scores that are considered to be unacceptably high for new traders. A good trader is one with a risk score of between 2 and 4 on a scale of 10. Once a trader’s risk score gets to the 5/10 mark, that trader cannot be considered a good trader.
These performance metrics for recognizing a good trader have been used by the writer of this article to test out the performance of a demo account on a social trading platform.
Four Leaders marked A, B, C and D are shown with these performance metrics.
- Leader A has a 72.11% return over 6 months, with a risk score of 6/10, a 7-day return of 519%.
- Leader B has a return of 12.99% over 6 months, a 300% 7-day return and a risk score of 4.
- Leader C has a 68.14% return over 6 months, a 66.36% 7-day return, but a risk score of 6.
- Leader D has a return of 64.4% over 6 months, a 7-day return of 58.02% and a risk core of 4.
Which Leader will best fit the classification of a good trader?
Leader A shows an unduly high risk score of 6/10 and a large disparity between the 7-day return and the 6-months return. This trader’s metrics indicate a trader who is unduly aggressive, uses too much risk, and has obviously had some losing months that have ensure that the 6-month return is far lower than the 7-day return.
The same can be said of Leader B, who has obviously had some bad losses to warrant only a 12% 6-month return. The 300% 7-day return is the hallmark of a trader who is gradually starting to take more risk in order to boost returns. Not a suitable option for a new trader.