Originally published by OpenMarkets
Anything with the word social in its name gets my immediate attention. Social investing conjures an image of a group of like-minded people sitting around a fire on a comfy couch, red wine in hand, and an animated discussion of what to do with the collective share portfolio.
While I’m sure such scenarios play out in real life, that’s not what social investing is all about.
The traditional concept of social trading saw investors following successful traders via a plethora of newsletters and newspaper columns, and later, email and social media. It also saw real clubs, where people met, pooled their funds and debated investments. Such clubs still exist – take for example ProShare Investment Clubs, which share the collective experience of 100,000 club members in 12,000 clubs across the United Kingdom.
Today’s version of social trading tends to be more sophisticated than the email newsletter, providing real time data and trades, phone apps and cutting-edge technology with the click of a mouse. Despite this, there remain a number of people who enjoy the social aspect of trading. In Melbourne, the ‘meetup’ collective has a group called Melbourne Traders who meet on and offline to enhance their investment and trading skills and knowledge.
How does social trading work?
According to socialtradingguru.com, social trading builds on the concept that the collective wisdom of thousands of traders is better than the wisdom of one.
Social trading hubs connect traders from all around the globe and create a network where they can share their views and trades; investors can then use that information to make social decisions rather than those based on quantitative data, company fundamentals or broker recommendations.
There are two ways investors can use social trading sites:
(1) As a source of information – the collective wisdom of many
In a blog earlier this year - 5 must-have apps for trading in 2016 - I reviewed Scutify, a social network built around the sharemarket. Users can build a watchlist and with the tap of your finger, bring up detailed information about a specific stock, pulling in relevant tweets, blogs and news articles. It also brings up ‘scuttles’, where any registered user can post some scuttlebutt, or information, about a specific company.
(2) To mirror the trades of ‘experts’
Other sites are dedicated to providing a platform to follow a specific investor – much like you follow someone on Twitter or LinkedIn (NYSE:LNKD). Such platforms allow you to view, analyse and comment on the performance of traders and – for a fee – copy trades executed by investors you choose to follow.
Mirror, mirror on the wall…
Not to remove any cred from the benefits of collective information, I’m going to focus on the second style of social investing…’copycat’ investing. Why would an investor want to copy someone else’s portfolio – and why on earth would they want to be copied? It’s a one word answer – money. You know it makes the world go round.
One of the largest providers of copycat investing is eToro. Its key message is: “Join millions who've already discovered smarter investing by automatically copying the leading traders in our community, or get copied yourself to earn a second income!”
Available online and as an app, eToro has grabbed the imagination of many, claiming 4.5 million users in over 170 countries (including Australia). Earlier this year, CNBC named it among the hottest fintech start-ups to watch. A 2015 report showed that about 50% of investors on the eToro platform copy other traders’ strategies, while 5% of investors are copied.
Most platforms offer a range of investment portfolios to mirror – shares, indices, commodities and Forex seem the most common. A number of platforms require trades to be executed via contracts for difference (CFDs) rather than trading in the underlying security, so it pays to do your research thoroughly and compare the options.
The benefits of social trading
Research from the Massachusetts Institute of Technology (MIT) demonstrated that higher returns are possible using social trading. Published by the Harvard Business Review, the analysis found that social explorers seek to “form connections with many different kinds of people and to gain exposure to a broad variety of thinking.” Those traders who found the ‘sweet spot’ – or in other words, the right balance of ideas from a diverse number of traders – were able to increase returns by up to 30%.
The research found that the rate of idea flow is a critical measure of how well a social network functions in collecting and refining decision strategies, and this idea flow must come from both within the network and outside of the social network.
Interestingly, this has a downside; it can lead to overconfidence and groupthink. Social learning improves decision making only when individuals each have different information. If everyone is reading the same business column, the same website and following the same twitter feed, social trading became “reliably unprofitable”.
The shrinking globe
A quick Google (NASDAQ:GOOGL) search found a surprisingly large number social trading platforms available, particularly in the forex space. While most are northern hemisphere domiciled and oriented, there are some Australian-based options available, all of which simplify investing globally. No more late nights for traders investing in global markets – investors in Australia can copy trades anywhere in the world while they sleep!
Social trading platforms operating under Australian financial services laws include:
Each of these platforms have embraced the fintech revolution. They are online and on app, providing social investors easy access through user friendly interfaces...well, that’s what they tell you! And, from what I have seen in demo-land, it looks impressive.
It’s a win-win for the industry; brokers get increased turnover, popular (i.e. well performing) traders can generate additional revenue, and the followers will, ideally, get access to traders who can generate returns which that investor would be unlikely to generate themselves.
Where does social investing fit in Australia?
When it comes to our Australian markets, the introduction of innovative social trading products has been almost glacial in pace. This is probably explained by two key factors:
Firstly, our very tight regulatory environment. ASIC has very strict rules when it comes to issuing advice, particularly in regards to issuing digital advice. The area of social investing/trading is still somewhat of a grey area when it comes to classification under ASIC guidelines.
Secondly, the online investing landscape in Australia is still largely controlled by the big four banks and for social investing to gain broad traction, it would need to be promoted and distributed by one of the majors. Apart from the potential regulatory risk/hurdles of offering such a service, these organisations would also be concerned re cannibalising parts of their traditional high margin platform businesses.
Despite this, there are options available. If you’re interested in exploring social investing, most providers offer a free demo. Sign up, take some play money and test drive the platform for yourself. Read the posts, suss out the top traders (and their track record), and importantly, read the fine print.
As with anything, you need to know what you’re signing up for. After all, if you’re going to share your trading secrets – or take on board the ideas of others – the platform needs to be scrutinised to be sure it meets your social and trading needs.