Social traders are betting on the wisdom of global crowds

But some doubt how influential the newest trading trend will be

THE FIELDS of social networking and trading are beginning to collide, threatening to change the way retail traders operate. A few weeks ago, legendary investor Carl Icahn tweeted that Apple was “extremely undervalued”, stating that his company Icahn Enterprises held a large position in the firm. Apple’s stock price soared in response, rising by roughly 5 per cent in less than two hours. For many, this event was a prominent illustration of the power of social networks to affect markets, and the potential synergies between the two.

By integrating the connectivity of sites like Twitter and Facebook with platforms for spread-betting and contracts for difference (CFDs), social trading companies aim to open up information for retail traders. One of the largest providers, eToro, already has nearly 3m users based in over 200 countries, and around 86m trades have been executed through its systems since it was founded in 2007. Although less than 7 per cent of its 150,000 monthly users are based in the UK, this figure has grown by 50 per cent in the past year.

COPY TRADING
Platforms such as eToro, ZuluTrade and Myfxbook allow users to communicate trading strategies through dedicated social networks, and automatically copy the trades of those with the most successful records.

Just as sites like Twitter provide a sense of the day’s news, opinion and reaction in a matter of minutes, social traders can take a reading of forex market sentiment, including the open and closed positions, proportion of winning trades, and the overall returns of other traders.

What is most unique about social trading platforms, however, is the ability to copy the trades of the most successful users (termed “gurus” by eToro), which allows a trader to stake a maximum of 20 per cent of his or her total portfolio on another user’s positions. The details of a user’s trading history are entirely transparent (see graph to the right), allowing users to make informed decisions about who to copy.

Traders following this strategy seem likely to benefit, with eToro claiming that the win percentage of copied trades is 87 per cent, compared to 74 per cent for normal trades.

And the website’s users are keenly aware of these benefits. “I prefer social trading because I can communicate easily with fellow traders”, says Mujtaba Bullionaire (muji3009 on eToro), as he wishes to be called, one of the most-copied UK traders. “It’s invaluable to get the views of others on currency pairs you are thinking of buying, especially when you are just starting out,” he says.

Mujtaba’s returns have been impressive over the last three months, leading to a sharp uptick in the amount of copiers he has (see graph). More followers means commission, with eToro reportedly paying $10 (£6.43) for each copier that places a significant amount on the guru’s trades.

WISDOM OF CROWDS
Academic research seems to support the claim that information flows around such networks can improve returns. In an experiment carried out at the MIT Media Lab with eToro’s platform, researchers designed an algorithm to optimise the matching up of traders with gurus.

The returns of the 500 traders were on average 10 per cent higher than those using conventional platforms, and 4 per cent higher than those who copied gurus without the recommendations of the algorithm. By encouraging the matching up of traders with a wide variety of gurus, researchers found that groupthink was avoided and profits boosted.

The idea of increasing the flow of information is firmly in the sights of the proponents of these platforms. “We believe social trading is doing something that has never been done before,” says Alon Levitan of eToro. “Instead of having all the knowledge ‘locked up’ within only a few individuals and institutions, it can be shared openly in the social network.”

Similar themes are gaining traction in other sides of the trading industry. The startup Tradable is aiming to “democratise” the functionality of trading platforms. Jannick Malling, the company’s founder, says “we allow traders to customise their trading platform. By offering an ecosystem into which apps can be inserted, they can choose from a huge range of functionalities, rather than being locked in to a specific set of features”. On the tech side, developers can spend more time inventing applications that suit traders’ needs, and less time on the maintenance of an entire platform.

Such initiatives are often touted as helping to close the gap in resources between institutional and retail investors – social trading by harnessing the “wisdom of crowds”, and Tradable by making software more responsive to the individual needs of traders. Tradable even recently teamed up with social trading platform ZuluTrade, offering its users the chance to follow and copy the ideas of others through ZuluTrade’s auto trade function.

DOUBTS
For some, however, the idea that social trading could permanently revolutionise the market for the better is misguided. Malling sees the sector as an increasingly important area. But he is not convinced it could replace conventional spread-betting and CFD trading.

“We view social trading as just one of many categories that we need to cater for. When you think about what it actually does, the functionality is not entirely novel.” Traders have always shared tips with each other, whether in person, over the telephone or in online forums. Social trading may upscale this, but many established City players say talk of an information revolution is overplayed.

Others go further in their criticism, arguing that there is scope for abuse on such an open network. A senior figure at a City firm says that social trading could be seen as “effectively unregulated investment advice. It can leave consumers vulnerable to poor performances by copying traders who may be churning their accounts just to gain commission.”

City Index’s Joshua Raymond, however, takes a more nuanced view, saying that “while there are indeed risks associated with social trading, when utilised correctly it can help traders to generate greater awareness of the different types of strategies out there.”

The rise of sites like eToro and ZuluTrade means that some of the more mainstream platforms are keen to incorporate social trading functions. Some firms, such as City Index, are even working on plans to introduce their own platforms. The influence of social networks on financial markets looks set to grow.