Social Trading: Which Investors Should You Follow?
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Social trading is a great way to get started with investing, but choosing the right traders to follow is no easy business. While good traders can be found on every social trading platform, it can be hard to spot them among a crowd of users with less-developed bankroll management skills and high-risk trading strategies.
For new social traders, it's necessary to do a bit of in-depth analysis in order to identify signal providers who're a good fit. Here's what to look out for.
1. Big fanbase
One of the easiest ways to spot a good signal provider is to check how many followers they have. On most social trading platforms it's possible to dig down not only into how many people are copying an individual's trades, but also how many followers their profile has overall. A large number of followers is a signal that an investor knows what he or she is doing, and makes as good a place as any to start.
Another important stat to check is how many copiers a user has. As a rule, if they have very few copiers and followers, it might be hard to trust them. But bear in mind, the most copied traders aren't always the best either. For example, some may have just used questionable methods to boost their popularity, such as by manually copying other traders or by creating multiple accounts and sticking with the one that, by chance, made a profit.
Perhaps the best indicator of a trader's popularity is the amount of money that's invested in them.
Platforms such as NAGA Trader, for example, provide really detailed stats that provide a breakdown of how much money a specific investor has been trusted with by other users. It also provides details on the average ROI returned to each copier.
2. Overall returns
Obviously, any trader with a negative return should be avoided. However those with extremely high returns may also be questionable. Profits of 70% or more per year sound tempting but they are unusual, and could be the result of risky trades combined with a huge slice of luck. Anyone who has a 100% return is a huge red flag, and has probably only achieved that by keeping losing trades open.
As such, it may be a good idea to look at their monthly average returns to ascertain if their performance has been consistent - it may well just be that they had a very lucky month but overall, are generating poor returns.
Ideally, it's better to identify traders that have shown consistent returns month in, month out. eToro provides an easy way to check traders' monthly performance at a glance with its color coded charts - if most of the months are green, with very few reds, you have found a consistent performer.
3. How many trades?
When evaluating any trader it's important to consider the total number of trades they have made. Those with only a small number of trades, say under 50, could well have gotten lucky. It's far better to choose traders with a large number of closed trades, at least over 100, to ensure they actually know what they are doing. If any trader can achieve good returns after making such a large number of trades, it's likely that their success is not down to luck alone.
4. Don't be fooled
Always, always investigate a trader's number of open trades, as not closing them is one of the easiest ways to trick followers. On ZuluTrade for example, it's possible to view a trader's open trades from their main profile page, alongside their overall trading history.
The thing is, the best traders know when they've made a mistake and when it's time to accept a loss before it becomes unbearable. As a general rule of thumb, traders with very few open trades with a success ratio of 60 percent to 80 percent will perform better overall than those with a winning percentage of close to 100 percent, but with many trades left open.
Leaving trades open so they don't impact on the statistics is one of the oldest tricks in the book that poor traders use, so always be sure to check.
5. Maximum drawdown
A key signal on every social trading platform is the maximum drawdown, which signifies how much money an investor lost before they started making profits again. Drawdown is an indicator of the reduction in a trader's capital after several losing trades, calculated by subtracting the deepest trough in their capital from their peak, with the value expressed as a percentage.
Traders with a very high drawdown can be risky to follow. They usually employ risky strategies and following them could result in your account being driven into margin call, which is a very bad result indeed.
Ideally, most risk-averse users will want to follow signal providers with a drawdown of around 20 to 30 percent, which suggests their trades are making slow and steady gains.
6. Activity levels
Be mindful there are different kinds of traders, so pay attention to their level of activity. For instance, some investors employ a long-term trading strategy with monthly or even yearly horizons, while others are known as "swing traders" and have an hourly or daily horizon. Then there are "scalpers", who aim to profit on market fluctuations minute-by-minute, or even second-by-second. Extra caution is advised for those who follow small-time horizon traders, as slippage - the delay, measured in seconds, between their trade and the autocopiers' trade - can take a big chunk, or even wipe out the profits from an individual trade.
For those interested in following scalpers, it would be better to use a platform that offers a price execution guarantee with no delays and no slippage, such as NAGA Trader.
7. Understand their strategy
Another consideration that's sometimes overlooked is a signal providers' overall investment style. Be sure to understand the strategies they use, which products they're trading, and why. After all, no trader is successful in every single market, like cryptocurrencies, stocks, forex and derivatives, at the same time. Some may diversify from time to time, but most will usually specialize in one or two markets. As such, it may be a good idea to follow different traders - one that specializes in crypto, another who's focused on stocks.
eToro offers a filter function that allows users to copy traders according to specific parameters such as the markets they trade in. NAGA Trader meanwhile shows a straightforward list of an investors' most traded assets, making it easy to see where they specialize at a glance.
8. Reach out
Last but not least, don't forget what social trading is all about. If you want to learn more about a trader, reach out and send them a message, or comment on their posts. It is, after all, a social experience where people come together to discuss and learn. Be active and you'll quickly find that social traders are only too happy to communicate with their followers and build up a strong rapport.