Social trading explained
Social trading is a popular way to access financial markets as it enables traders to replicate the positions of others and interact with their peers. Discover how social trading works and the risks involved.
What is social trading?
Social trading is a form of trading that enables traders or investors to copy and execute the strategies of their peers or more experienced traders. While most traders perform their own fundamental and technical analysis, there is a class of traders that prefer to observe and replicate the analysis of others.
Social trading is often thought of as a type of social network, as the function enables traders to interact with others, watch each other’s trades and learn about decision making processes.
How does social trading work?
Social trading works by creating quick access to financial markets, enabling beginner and experienced traders alike to share strategies and copy each other’s trades. In fact, new technology and advanced platforms have made it easier than ever to become a social trader. You can either use a comprehensive social trading platform, or adopt individual elements of the practice.
Some traders might want to use a fully integrated social trading platform, which facilitates the complete sharing of trading strategies using a ‘copy trading’ or ‘mirror trading’ feature. As with a social networking platform, a social trader could choose to ‘subscribe’ to another trader’s channel, whose positions would be broadcast on a live feed, with the option to copy their trades. So, if trader A executes a trade, trader B would automatically execute the same trade.
The incentive for experienced traders to share their strategies is that they are often rewarded with both money and status – social trading networks usually have a leader board based on popularity and success rate.
Alternatively, traders might utilize the principles of social trading, but maintain control over their trades by using a range of signals and indicators. By looking at the market sentiment and activity of other traders, social trading can act as confirmation of other forms of analysis.
Social trading: which markets can you trade?
Social trading first started in the early 2000s, when it was used to mirror successful forex trading strategies. Since then, retail traders have begun to use it for an ever-growing number of trades across asset classes, as anyone can participate with little-to-no previous experience of trading. So, social trading shares, commodities and indices has also become popular.
What you need to know before you start social trading
Social trading is not for everyone. Although it has been praised for knocking down some of the barriers to financial inclusion, it has also been criticized for downplaying a lot of the knowledge needed to properly negotiate financial markets.
One of the largest faults a social trader can make is thinking that the method eradicates risk completely. All trading involves risk, and traders are likely to make a loss at one point or another. So, the idea of trusting a third party’s judgement – while retaining all the risk of loss – is seen as a large drawback of social trading.
Financial markets require knowledge and patience, and although social trading can potentially help you skip a few steps, it does so at the expense of experience. It is important to make sure that you understand exactly what you are doing and have an appropriate risk management strategy in place.
When you start social trading, you are taking on another individual’s trading plan, but a plan should be unique to you and your aims. Although the strategies of others can be used to create some guidance for your trades, their plans will be suited to their own goals, motivations and so on. Everyone has different risk appetites and capital available, so trading the way someone else would isn’t always necessarily a good idea.
How to start social trading
IG provides a range of ways to get the benefits of social trading, without giving control of your strategy to a third party. However, it does not offer a fully integrated social trading platform.
The primary benefits of social trading include being part of a community that shares advice and trade ideas, establishing buy and sell signals for trades, gaining an awareness of market sentiment and the automatic execution of trades. We’re going to look at each of these in turn, and alternative ways to trade socially.
Social trading enables you to replicate the buy and sell strategies of other traders. Although this can reduce the amount of preparation you need to do, it could also mean you become out of your depth quickly. There is no guarantee that the third party you have chosen to copy has done the appropriate amount of analysis either.
By using technical analysis, you can identify the right time to trade on a range of markets including forex, indices and commodities. The signals function of the IG online trading platform gives you buy and sell suggestions from two third-party providers: Autochartist and PIA-First. Both providers monitor the markets on your behalf, giving you access to in-depth technical analysis and professional expertise.
Although the signal service gives you detailed research, you are still making the decisions and retain full control over your trading.1 This means that you can fit the trading strategy to your needs.
Market sentiment indicators
One of the most common ways to identify trends and the inclinations of other traders is to use market sentiment. Market sentiment is essentially a representation of the mood of financial market participants, but it can give you insights into what is being traded and when.
Gauging market sentiment can be difficult, as there are so many factors that can influence whether traders are optimistic or pessimistic. But there are a few ways to measure market sentiment, such as:
- The Commitment of Traders (COT). The COT report is published by the Commodity Futures Trading Commission (CFTC) every Friday and shows the net long and short positions of speculative traders. It can help outline how other traders are positioned and the overall attitude of the market.
- IG client sentiment. Real-time trading data from IG shows trader sentiment across key markets including shares and forex. You can see the information displayed at the top of IG market data pages – such as those for EUR/USD, gold and Apple – simply by searching for your chosen market via the search bar. It appears as a percentage of IG clients trading in a certain direction during the current or most recent trading day.
- The volatility index (VIX). The VIX tracks S&P 500 options prices and measures the implied volatility of the stock market. Rather than suggesting the price direction, the VIX shows how much fear is on the market – the higher the implied volatility, the more fear about a current trend, where as low volatility suggests a more stable market.
- High/low sentiment ratio. This indicator compares how many shares are at their highest level over the previous 52 weeks compared to the amount making 52-week lows. If the average trend is toward the lows, it shows a bearish leaning and if the trend is toward the highs, it shows the bulls are in charge.
Social trading on MT4
The popular trading platform, MetaTrader 4 or MT4, has a function called ‘sentiment trader’, which enables you to analyze market sentiment and view historical sentiment charts that indicate how other traders have performed.
The service is relatively easy to understand: it displays the percentage of traders who currently have, or have previously had, an open buy or sell position on a particular asset. The indicator uses information from real accounts, rather than just price action.
Adding indicators to your MT4 account can help to enhance your trading and take greater control of your positions.
Get access to a range of MT4 apps and indicators, including sentiment trader, with IG.
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