Every time I hear about the concept of social trading, the only thing that comes to mind is one of Gordon Gekko’s famous quotes from the movie Wall Street (original): “…cause they are sheep, and sheep get slaughtered”
A sheep is an investor who has no strategy or focus in mind. This type of trader simply listens to others for trading tips, and often misses out on the most profitable moves in the market. This sheep/herd mentality often causes the “Lemming” effect- an act of an investor following the crowd into an investment; consequently resulting in losses.
In an interview with Jack D. Schwager, author of Market Wizards (one of the most popular trading books), he said the basic concept of his book is for traders to develop a trading methodology that fits one’s personality, as opposed to seeking someone else’s approach, which is an absolutely critical element to succeeding as a trader. He goes on further to explain that most trader fails because they listen to “experts” and chase trading fads instead of doing the hard work of developing their own methodology.
So Why This New Social Trading Trend?
I partly contribute this social network trading concept to the marketing and promotion of some brokerage firms, because this style of trading generates volume and volume means profit for the house. But before blaming the ‘big bad brokers’ we have to look at a few other factors that led to this approach by these brokers.
1) The evolution of online trading has created more novice traders who are ill prepared to sustain the ‘hardship’ of the markets.
2) We have become a society of instant gratification. Most novice traders are content to have 50 small profitable trades that result in a $1,000 gain rather than 45 small losses and 5 profitable trades which result in a $2,000 gain.
3) These traders are perhaps unaware or choose to ignore the paradoxical intrinsic nature of trading, which is in order to become good at the craft you have to lose (if you are playing by the rules). But most people would rather bypass these steps and go for the easy route. So the brokers are simply offering good customer service to retain their clients.
The Pros and Cons of Social Trading
Like any form of technological innovation, there are some advantages to social trading. Mainly it provides a trader information and insight on the general market sentiment. So, a trader can use this information as an indicator to trade with or against the trend. Social trading can also help a novice trader learn from an experience trader while forming his/her own strategy, and preventing the downfall of the trading learning curve. However, where I think it could be dangerous is when traders are blindly following and executing trades based on others’ strategies.
Some may argue with the rise of quants and algorithmic trading, social trading is the only chance the average trader has to keep up. But according to Jack Schwager, “The same basic concepts that are critical to trading success remain as valid now as they were a generation ago when computerized trading was in its infancy.” I have not yet heard a trader who made a killing by following others. It’s usually the contrarian, maverick, wolf trader who gets the big catch. In essence, social trading could also be a mirror of your trading personality: are you a wolf, bull, bear or sheep?