Part 2. Pluses and minuses of social trading
Knowing the pros and cons of social trading is crucial to starting your social trading path in the correct direction. Pluses of social trading are obvious benefits of getting educated and sharing ideas. This sharing of ideas is critical in online financial trading as there are many news and events happening and receiving ideas and analysis from others means there is more likelihood of not missing crucial information. One of the main advantages is the required capital is very small. Some copy trading strategies are possible from just 50 dollars and even below, while previously millions of dollars were required to get a Wall Street hedge funds account.
FX social trading pros
There are five main benefits of employing the forex social trading approach:
1.Shared expertise and trading skills
Gone are the days when investors needed millions of dollars to open an account with hedge funds and generate passive income from the fund's trading activities. Many modern platforms require very small upstart capital and traders have a possibility to select their preferred strategy from a large list of profitable traders. With entry barriers shattered, more and more beginner investors and traders are joining forums and using social trading tools to enhance their chances of success. By outsourcing trading skills and analysis, traders can gain access to many different types of analysis and select the best trading setups.
2.Time-efficient
By having an opportunity to access other traders' ideas and expertise, the time needed for developing your own approach has been reduced greatly. Reclaiming your weekends is probably one of the best benefits of social trading. Manual traders spend sometimes 12+ hours weekly analyzing charts and developing viable strategies. Social trading platforms have the potential to greatly slash analysis time. For example: You are trading EUR/USD but get a signal about GBP/USD price prediction due to Brexit. You can now use someone else's analysis and cut time by 90%. Otherwise, you would have to develop a strategy specifically designed for GBP/USD and spend hours and hours on testing it to ensure profitability.
3. Educational Value
Earning while learning is yet among the list of benefits of social trading. Social trading platforms which are built into the website and platform enable traders to quickly translate theory into practice. New traders gain market intuition quickly and discover which strategies are not working in real markets. For example, it can take several blown-up accounts before the trader concludes that martingale systems are very risky, while this is written on every trading forum out there.
4. Diversification
Diversification possibilities are also FX social trading pros that can not be underestimated. By getting ideas from different sources with different strategies and assets, traders can spread their risks across asset classes and strategies with just a few mouse clicks. While social trading is not fully automated, brokers have semi-automated social trading features where traders can copy many different strategies and trading signals. When there is no single point of failure, even if one market performs terribly, there are still other trades to make up for those losses. This multi-provider approach ensures stable returns during events like Fed rate announcements and many others.
5. Bypassing Psychological Traps
Emotions are the number one enemy of a trader. Feelings such as fear and greed can seriously damage a trader’s performance and this is where social and copy trading comes into play. Human traders can panic due to volatility and other extreme factors in the markets while copy services and semi-automatic social trading tools enable them to make most of trade execution tasks automatic, thereby bypassing emotional biases 99%. Here are the main emotional challenges that can be completely avoided using copy and social trading:
- Revenge trading after losses - This is a serious problem among novices who often will increase their position size in hopes of making losses back. More often than not, they end up losing even more due to market dynamics.
- FOMO chasing during rallies - Fearing of missing out is a serious emotional challenge where traders buy tops and sell bottoms so as not to miss opportunities.
- Premature profit-taking - Traders often cut profits while letting their losses run, which can end up in poor [performance.
By automating most of your trade execution, all these challenges can go away as automated social and copy trading services also manage stop-loss and take-profit orders, ensuring stable earnings.
Forex social trading cons
Surely, with advantages, there always come certain downsides and Forex social trading is no exception from this universal rule. There are mostly hidden pitfalls with social trading which carry unique dangers requiring deeper understanding from the trader’s side.
Chasing the performance
The “Star Trader” mirage occurs when a trader chases performance and winning streaks are mistaken for skill when in fact it is just luck. Short-term results ignore drawdowns risks which inevitably occur and traders can get exposed to larger risks thinking they are already pros. Some providers might manipulate stats or they might be new on the market and the performance is for a short period not a long term. The strategy can show huge profits for 2 weeks or even 1 month but then the drawdown period comes and losses eat most of the profits.
Hidden fees and commissions
Hidden fees and commissions are silent killers of copy and social trading returns. Hidden fees are Forex social trading cons that require traders to carefully analyze their social trading services and check for all fees and commissions including the fee charged by the strategy provider. Here is an exemplary fee structure for social trading services:
- Profit share on gains - charged by the strategy provider
- Spreads - If you are copying a scalping strategy that makes 4 pips while your spreads are 2 pips on average then you might lose money despite high win rates.
- Swaps or trading commissions - Trading commissions may apply on lower-spread accounts and swing traders also should look for swaps (overnight commissions).
Hidden fees are generally one of the main risks in online financial trading and traders should always calculate their spreads and other costs to ensure trading performance.
Over-reliance
Over-reliance on your Social trading forex and copy trading forex strategies is another challenge for copy traders. Many investors copy strategies directly without knowing how the strategy works and where to set stop-loss orders. This is a prominent social trading risk every beginner needs to understand, whether you are copying someone else’s strategy or using EA you have not programmed yourself, it is essential to understand how the strategy works and what are its pros and cons.
Platform risks
This is mostly a minor issue and depends on the trading software that is used for social trading and copy trading services. While reputable brokers have advanced tools with good maintenance, unregulated brokers might suffer from low-quality platforms. Another important challenge is to have a stable internet connection so that your platform can get signals and execute trades without issues otherwise losses would occur and copy traders should be cautious.
Scammers and fake gurus
This is probably the most widespread of social trading risks, as many fake gurus advertise themselves and their systems as infallible. Scammers can also lure traders with their exaggerated return promises and this is why traders need to be alert and evaluate trading systems strategically. The common signs of scams and fake gurus include “live” results showing no losses and vague strategy descriptions where the provider speaks endlessly about how their strategy can provide the edge but never delves into the strategy itself.
Mitigating social trading risks - The 4 steps
Mitigating the risks described above is critical to making a passive income source from social trading services. Your mantra as a social trader should be “Never trust, always verify”. In practice, this means to ensure your strategy provider has at least a year of stable profits from their strategy without significant drawdowns. Generally, it is better to select strategies that have the lowest drawdowns. Checking for 12+ months of verified Myfxbook results will provide a solid chance of acquiring really quality strategies that work in real markets and are well-tested over time.
Check how well the strategy handled drawdowns and if you see a large spike of drawdowns it means the strategy might be extremely risky or a martingale system that is guaranteed to blow up the account.
Operate like a hedge fund manager
It is critical to diversify your trading to ensure the risk is always spread among several strategies. Blindly copying only one trading strategy is a common social trading risk management among beginners. Hedge fund managers always have their portfolio diversified in several trading or investing activities and you should be doing similar to maintain your capital and generate consistent profits. If one strategy fails to perform, you have others to balance its drawdown.
Algorithmic safety nets
Seasoned investors often use automatic stop-loss at 1.5x the provider’s average risk and you could also set a daily profit cap to lock in gains. It is not necessary to make millions in one day and lose your money as a result of greed, by locking in profits daily, you ensure steady growth of your investment.