The trade replication technology behind shadow trading has existed for well over a decade – if not two. But what marks social trading out as different is the concept of marketing an individual trader’s superior (or reportedly superior) skills to benefit other retail traders or investors, according to Javier Paz, senior analyst - wealth management with Aite Group. “There have been individuals around for many years in trading who claim to have skill sets which they offer to benefit others ie portfolio managers, mutual funds or CTAs,” he explains. “Copy trading is an extension of that world, where trade replication technology merges with the practice of end clients viewing - or harnessing - the performance of talented traders.”
But then, according to Paz, somewhere around 2008/2009 we started to see platforms emerge to address and popularise that need, or demand, because foreign exchange was becoming an increasingly popular asset class at the retail level. He adds: “So we saw an expansion of the money manager concept to include trade replication technology and go by the name of copy trading, mirror trading, social trading, etc.” Now, social trading is available to any retail investor interested in learning more about the financial markets in an online community setting. In fact, millions of people have since signed up to social trading networks, says Ashley Globerman, wealth management research analyst at Celent, who expects that this trend will continue as social trading becomes more familiar to the public. “Social trading appeals to a range of users,” she adds. “It is especially appealing to novice traders and mass market/affluent individuals who benefit from the expertise of skilled traders.”
An attractive approach
On top of this, most social trading networks do not have a membership fee, although they do require a minimum investment - ranging typically between $50 and $1,000. Globerman says it is also worth noting that following the crowd comes with its own risks. “Although experience is not a requirement to join a social trading network, having some knowledge of the financial markets is recommended,” she warns. In addition, a number of brokers provide private social trading networks only to a certain segment of investors (mass market-high net worth individuals), while others allow access to all customer segments. Novice traders can also gain trading experience by following more experienced traders and self-educating through educational portals on social trading sites, according to Globerman.
Iqbal V. Gandham, UK Managing Director of eToro, agrees, adding that the eToro platform views traders as belonging to one of two categories: either professional traders, or those who want to learn how to trade. Copy and social trading has value for both of these sets, he claims. “For the professional trader, it’s always good to run your strategies, or ‘double-check’, with fellow traders, or to compare your strategies,” Gandham says. “Social trading allows you to do this very easily.” Furthermore, it also provides this group of traders with a way of earning additional income. On the eToro platform, for instance, if you have people copying your trades then you can earn a percentage of copy assets under management. “For those that want to learn, what better way to do so than from people who are actually trading?” Gandham asks. “Why not ask the people who are already trading their own money, in real time? You can copy them with real money or a virtual account.”
But there are also a growing number of platforms which have adopted a different approach altogether, such as Tradency which only offers B2B trading technology, not B2C. “We are a pure technology provider of automatic/copy/robotic trading - the term robo-advisory is also becoming more and more popular - to financial institutions,” says Gil Eyal, co-founder and president, Tradency. “We provide our platform and products to financial institutions and they provide the service to their customers.” According to Eyal, the main differentiator between Tradency’s model and social trading is that social trading is open, so anyone can follow anyone else in their network. “Our customers (established financial institutions) are reluctant to expose their clients to the potential branding, commercial and regulatory risks inherent in social trading with someone who is unqualified or unregulated,” he explains.
Lay of the land
Instead, Tradency’s goal is to enable retail mass market traders to, “use, enjoy and benefit from the same tools and technology that is available to high net worth investors, or institutional investors” Eyal claims. “It is a highly competitive market and they actively use automation, algo-trading and auto trading to provide better yield and services to their customers,” he adds. “But social trading is not high on their list.”
In general, three different business models have emerged in the social trading sector in recent years, according to Globerman. These are:
• Broker-only networks. Brokerage firms which added social and auto-trading features to their existing brokerage offering. These firms derive their revenue stream from the spreads on each trade.
• Network-only networks. These firms make their revenue by charging the brokers who introduce clients to their site.
• Broker-and-network networks. Essentially, these are a combination of the other models. This model enables clients to sign up to a social trading platform via other brokers, as well as to their social trading network. The firm generates its revenue by making the full broker spread for any clients signed up directly to their site, as well as part of the spread through their introducing broker deals.
But there may also be some inherent problems with main stream social trading models, claims Juan Colón, CEO, Darwinex. “Some platforms have realised that there is a business model around people providing their trading data for free - and then using that data for their own purposes,” he explains. “And social trading sounds kind of cool at first. But what happens if you are a very good trader what is your incentive to social trade with someone less adept?” According to Colón, the better the trader is then the less they tend to contribute. “Social trading would be a great concept if it wasn’t for the fact that the next George Soros would never participate in it,” he adds. “It just doesn’t pass the incentive test.”
Instead, Darwinex’s model is more of a ‘hedge fund as a service’ rather than a social trading outlet, according to Colón. While he believes there is nothing wrong in sharing trading information, he believes the key to success lies in adequately compensating the trader for doing so. In addition, social trading models generally allow traders to copy the trades they can see. But there is nothing stopping them from then re-selling that information and collecting the success fee, without having paid the success fee in the first place. With Darwinex, traders can replicate trades that they do not see - and which they cannot track - without having paid the 20% success fee, the same as that charged by hedge funds. “On that basis, the good trader does have an incentive to allow their trades to be replicated,” Colón explain. But in legal terms, only regulated asset managers can collect success fees, but becoming a regulated asset manager is too expensive for most independent traders, he adds. “So traders stay unregulated, they sell trades to a regulated asset manager, such as Darwinex, who has permission to sell on to investors for a success fee,” Colón says. “It is a data-for-success fee agreement, which is legal because we carry the regulatory permissions to charge this fee to investors.”
And according to Gandham, this may be part of a wider trend where technology is powering greater levels of transparency in the markets. “The world of trading and investing has been hidden behind closed doors for a long time,” he explains. “There’s currently a call for more transparency in investing and I think the same needs to be done in trading.” In Gandham’s view, there is no better level of transparency than being able to log on to a platform to view what everyone is doing, in real time. Jonathan Adest, CEO at Tradeo, agrees, adding that social trading platforms can now provide clients with access to innovative technology, such as accurate market feeds, advanced charting and ground-breaking social feeds. “This enables a completely new way to trade online for investors,” he says. “Tradeo’s technology represents a quantum leap in the quality of a trader’s overall online experience.
Mobile and social communication channels are also further facilitating the adoption of social investing by allowing traders to implement financial investing into their day-to-day lives, Adest claims. “A trader no longer has to stay connected to three monitors, he has all the information he needs on his phone,” he explains. Ultimately, people now want to be connected all the time, they want to be online and they want to be communicating with their peers, according to Gandham. “Ten years’ ago, people were trading in silos, independently,” he explains. “Back then, you may have gone to an online forum, asked a question and then waited some 30 minutes or an hour for a reply. Now you can chat in real time - that technology was just not available ten or 15 years’ ago.”
Technology and services
Furthermore, investor demand is currently focused on looking for two key tools in a trading platform, Colón adds. The first is risk management technology that protects investors, so focusing on the return of capital. “We have a built-in risk management engine that manages investor risk independently from what the trader does,” says Colón. “The technology replicates what a hedge fund middle office does and we offer it in the in the cloud.” He adds that the second tool tackles return on capital, which Darwinex offers through a scoring toolkit whereby investors can differentiate between the “merely lucky and the genuinely skilled” traders. “Our platform currently offers FX and indices trading, and we’ll be adding single stocks and the most liquid futures as well by the end of the year,” he says, adding: “The combined benefits of protecting intellectual property, built-in risk management engine and diagnostic tool kit sets us apart from pretty much everybody else.”
Social trading networks, including Tradeo, are also constantly on the lookout for new features, claims Adest. “We’ve spent the last three years working on a suite of exceptional social trading tools, but it’s an ongoing pursuit to keep looking for that next feature,” he adds. So when a trader is trying to decide which social trading platform to use, he should always ask himself if he is getting all the relevant information, Adest says. “Our clients for example, enjoy a competitive edge gained by access to the insights and collective wisdom of our huge trading network,” he explains.
In turn, platforms such as eToro also seek feedback from existing customers to determine which new trading instruments to develop next. “For instance, digital forex is something we’ve uniquely added,” says Gandham. “We’re the only platform to currently offer trading in traditional forex and also digital forex, such as Bitcoin and Ethereum.” Additionally, all of eToro’s product functionality is linked to transparency and making trading even easier, Gandham claims. “We’ve also recently launched copy funds, so in addition to being able to copy people trading individual instruments you now also have the ability to copy people who are trading a portfolio of instruments,” he adds. “For cross asset class investors, we have a top traders fund where we algorithmically select the best performing traders every quarter. They trade a myriad of asset classes.”
|MODEL||SOCIAL TRADING FIRMS||EXAMPLE|
|Broker-Only||BelforFX, eToro, FxPro||FxPro is a FX broker that launched its own social copy trading platform, called SuperTrader in 2013.|
|Network-Only||ayondo, Currensee (acquired by Oanda late 2013) MyDigiTrade, Myfxbook||ayondo was founded in 2010 and previously required brokers to sign up with a separate partner broker. Although recent developments at ayondo provides its own broker partnership option.|
|Broker and Network||ZuluTrade/AAAfx||ZuluTrade was founded in 2007 and provides access to over 40 brokers or its own broker, called AAAfx.|
In addition to the range of instruments available to retail investors, retail investors should also weigh up how long a social trading platform has been operating. Gandham suggests looking for a platform that has been around for some time and has a stable, scalable business model. He adds: “Also, I think that the customer support and user experience you get is vital. Irrespective of the industry, we all want to be able to pick up a phone and talk to somebody.” For Eyal, the quality of execution, content and the quality of the broker should be key considerations for retail investors when they are making their selection. “As our operation is B2B, our customers are financial institutions such as retail brokers,” he explains. “When a financial institution choses an automatic/robotic platform to offer to its customers, there are several additional elements he needs to consider.” These include: scalability, stability, customisation, fit to regulation, experience of the technology provider and long term partnership capabilities, according to Eyal.
And as the technology behind automatic/robotic platforms evolves and development and maintenance costs surge, there is a competitive advantage to be found in forming strategic partnerships with technology and service providers. Eyal explains: “We specialise in developing and providing such services at a competitive cost and provide several partnership models. The adoption of our technology by top financial institutions shows their recognition of the value in our such solutions.” The opportunities for such white label or business partnerships with Tradency, for example, can range from integrating its branded product to a fully-customised solution - which can be provided as a SAS model or as a hosted, on-site solution.
Yet despite the continued evolution and variety of business models available to the retail sector, questions do remain about the long-turn viability of the social trading concept. According to Paz, there are some obstacles that stand in the way of it going mainstream. “Part of that is the way in which you scale up the performance of the trader, or group of traders,” he explains. “Copy trading is dependent upon an individual or a group of individuals generating alpha - a return above market expectations. By and large they are not institutional traders but rather amateur traders - and that leads to inconsistent returns.” As a result, Paz argues that a lack of, or substandard, risk management in the trade leader, ie the trader adding the copied trades, is a major challenge to generating predictable results for a large base of “would-be copiers” over time.
“There has to be an equilibrium between the value of the alpha generator, the technology being distributed and the benefit to the end user,” Paz warns. “That equilibrium has not been found yet.” The main problem, he suggests, is that you can have a great performance by some traders but it is not sustainable, or you have technology that costs too much to the end user. And as long as these challenges remain unresolved, Paz believes that the appeal of social trading will be limited to certain groups. “The retail market in general is highly fragmented,” he adds. “In order to grow, you need to have good institutional relationships with brokers who themselves are aggregating clients, or you need to have a social network that is self-sustaining and growing.” Therefore, the key issue for this sector lies in systemising the process and foolproofing it, so that the end user can determine what kind of social trading they are exposed to, Paz argues. “That is still not happening enough, or not happening at all,” he says. “We are still seeing social trading presented as a novelty that can produce certain returns.”
But according to Gandham, social trading can play a critical role in changing the way we think about trading and in making it available to a much larger audience. “The gap between the world of trading and the world of investing is certainly closing,” he adds. “The successful platform of the future is going to be one where you can copy investment strategies as well as trading strategies.” In addition, he says that eToro is seeing a shift in interest from general forex trading to a growing interest in trading digital forex, such as cryptocurrencies. “But the question is – how do you trade them?” he asks. “You trade them on a platform where there are experienced cryptocurrency traders and can copy them.” The second shift he identifies is demand for trading a pool of instruments, instead of just individual instruments.
The road ahead
The future will ultimately bring this revolution full circle, adds Colón. “The next big thing will be to level the playing field so that anyone can compete from home with the big guys,” he argues. Yet while the technology is there, in his opinion there are still two things missing which would allow this to be achieved. One is capital, and that is where crowdfunding comes in, according to Colón. “Our technology allows a crowd of retail investors to fund strategies, on merit,” he explains. The other missing element he identifies is information. “The small guy doesn’t really have access to the same information as the big guy,” he says. As a result, Darwinex is collating strategies based on the behaviour of the trading community. “Individually, none of them have all the information, but they can see a joint poll,” Colón explains. “Suddenly it’s not just the big institutions who know everything. You have the technology, the software, the capital and the information - a level playing field. At that point, the game changes.”
Yet in Eyal’s opinion, it will be hybrid services which truly hold the key to the future successful application of automatic trading. “We’ve seen in many markets and financial segments the need for efficient execution, accuracy and automation which algo/robotic technology provides - but combined with the trust and support of a human advisor,” he explains. “It is very important that financial institutions provide the tools and technologies that allow the retail user to get the best of both worlds.” As such, he believes there is a growing need for a holistic platform, one which supports multi-asset trading and a diverse range of strategies. “There is a competitive advantage in offering overall optimisation to retail users,” Eyal argues. “These are the tools which I see as potentially strong candidates for future success.”
Spreading its appeal
Overall, social trading platforms will continue to increase their market share and have an impressive number of clients, adds Globerman. Celent also expects that social trading will continue its growth in popularity among the retail investor population as firms continue to launch features, expand their operations and access new clients, she says. In addition, the research and consultancy firm estimates that factors such as an increase in the Internet penetration rate across Europe and the US over the next few years, combined with the continued proliferation and affordability of smartphones, and a growing population of self-directed investors who are increasingly tech-savvy, will contribute to a positive growth rate of social traders.
“But despite these positive projections, social trading firms will need to overcome several challenges before becoming a significant threat to traditional institutions,” Globerman warns. “These challenges include impending financial market regulations, building trust among its users, and expanding its functionalities, such as asset class offerings, mobile/tablet trading, and integration with social media networks.” However, Celent still expects that social trading will continue its growth in popularity among the young retail investor population as platforms continue to launch new features and adapt to impending regulations, thereby expanding their operations both domestically and internationally. “Traditional institutions, in order to find their place in the social trading world, will need to evaluate how they will fit into the social trading landscape,” says Globerman. She adds that these institutions should also consider building out their own social trading platforms and/or acquiring social trading networks - while adhering to financial market regulations. Yet while we cannot tell what other surprises the future will bring, Adest predicts, we can be certain that it will be crowed-wisdom oriented. “Social trading is the future of online investing,” he concludes.