social trading

The Benefits and Drawbacks of Social Trading Communities

Social trading communities and networks have become very popular of late. Their growth in popularity is directly tied to the growth of online social networks, as a whole, but the trading communities have taken on a new dimension.

Instead of just simply being a social community where individuals who share a common interest can meet and share their thoughts and opinions, many social trading communities have turned into de facto investment advisory services. Like any network of people, online or off, certain individuals will rise above the crowd as leaders, and others will be followers. In the case of a trading network, some followers will trade based solely on the recommendations of the leaders. In some cases this works out well, in other cases…not so much.

Many of these communities allow you to establish a trading account with their brokerage operation and have buy and sell trades automatically executed as the trader of your choice executes their trades. It can be very difficult to find a legitimately successful trader in these communities. However, if you do, and choose the right trader to trade along with, you can make money, just as the pro does.

The Benefits

The biggest benefit to social trading communities is the free flow of information. When participating in these networks, you can often find an important piece of news being discussed that you may have missed on your own. You may see a chart posted or a trade recommendation that opens your eyes to a potential entry or exit point.

These networks are also great for getting second opinions on trade ideas and trading strategies. Often times you’ll think you have a can’t miss trade on your hands based on a certain chart pattern, but somebody else may have already seen this pattern fail, and can tell you why. Sometimes just getting a different point of view can be invaluable. After all, any professional trader will tell you that how much you make isn’t as important as how much you don’t lose. Alternate opinions can help you avoid losses.

The Drawbacks

First of all, you don’t really know who your “professional trader” is on the other end of your computer. It’s easy to create bogus personas on the internet, and the 25 year veteran of the trading pits you’re following could actually be a 19 year old kid who took a free technical analysis course online, and is now touting himself as a trading genius…or worse yet, a scammer who wants you to buy over-inflated stocks.

Secondly, even if you are following a true professional trader, they aren’t always right. There are two drawbacks here. First of all, it’s human nature to pick the “hottest” trader to follow…you know, they guy who has 20 winning trades in a row. The reality of the situation is that hot traders get cold and the average of gains and losses always regresses to the mean. In other words, you’re probably going to have missed his hot streak, and be trading along for a cold streak.

The other drawback here is your professional trader is likely to be using professional money management strategies. most professional traders never put more than 1% of their portfolio at risk on any given trade. If your account is large enough to trade this way, or if you get greedy on a trade that goes bad, your account can be wiped out quickly.

Bottom Line

Social trading communities should be looked at as a trading tool, not something that should be blindly followed. Use the information available to your advantage, but don’t ever blindly follow somebody’s buy and sell recommendations. Always do your own due diligence. After all, if making money in the market was as easy as clicking your mouse to follow a trader, everybody would be rich.