In a poll we ran on the social trading website last year, 67% of the respondents said they already lost money with social or copy trading. Based on our experience and feedback we received here are the top 5 most common reasons why investors lose money on social trading networks or copy trading platforms:
- Unrealistic Expectations
- No Diversification
- No Effort
- Poor Risk Management
- No Patience
The big attraction of “social trading” or “copy trading” for most people is the opportunity to make large gains with little investment.
With standard stock trading you purchase the shares and pay for the full amount upfront. Say you want to make $1,000 than you’d need to invest $10,000 if you expect the share price to go up by 10%.
With CFDs (Contracts For Difference), spread betting or Forex trading you can leverage the money invested. Even with an investment of $100 you can potentially make $1,000 in a short period of time.
The adverts and promotional materials used by the social trading networks and brokers like to highlight the huge potential gains. Look at the results of the highest ranked traders on most networks and you’re likely to find historical annual gains (ROI) of over 100% and sometimes even over 500%.
When people see these exceptional results, they set their expectations accordingly. However many fail to realise that by magnifying their potential gains, they’re also magnifying their potential losses!
Pretty much with anything in life, the more time you invest in something, the better you’ll get at it and the more rewarding it is. The is very true in terms of social and copy trading as well.
While some ads may want you believe that you can “sit back and let others trade for you” it certainly isn’t as simple as that. If you diversified your investment in the top 5 most popular traders on ZuluTrade 3 years ago (f8, for333, denganyouqianle, yamatofx2vera and adnan essam maloma), depending on your risk settings, you’d be left with very little. And I could have taken pretty much any social trading network or copy trading platform as an example here.
With a little bit of research you could have noticed that most of these traders were applying a high risk strategy (ROI of > 400% should get some alarm bells going). But even if you’d invested in them you’d pretty soon have worked out the risk if you monitored their trading style, results and comments.
But even if you find a trader or system which makes you good consistent returns, the effort required on your behalf doesn’t stop. If you don’t monitor them (and take your profits) you’ll likely lose in the long run. When a trader or system does well in certain market conditions there’s no guarantee they do well in others. Traders are also human and there are plenty of examples of traders increasing risk and blowing their accounts after a poor run of results (and that’s not only true in the world of retail social trading but also with highly regulated corporate traders).
And just think about it, the same is true for other investments too. If you looked at stocks or funds 3 years ago, based on historical results you’d probably have invested quite a bit in commodity related ones. You might still have done fine with them for a while, though if you kept them for 3 years you’ll likely be left with half or less of your investment by now.
FACT: If you go in with a “fire and forget” attitude you will always lose in the long run.
So DO NOT select the most popular traders and copy them until you eventually lose.
TIP – what effort is required:
- Learn the basic principles of Forex and trading with leverage
- Learn how to use the social trading platform (especially how to manage risk) – try with a demo account
- Analise the traders to follow and copy
- Monitor your performance and refine portfolio
- BONUS – follow the market news yourself
Needless to say that any financial adviser worth their commission would tell you to diversify your investments. And this is also true with social trading.
Why would you put all your eggs in one basket and invest all your funds in just one trader or signal provider?
Spreading your investment between a number of traders should reduce your overall risk. Just in the same way as investing in a portfolio of stocks does compared to buying one single stock.
Every networks has a good choice of different traders available for you to follow and copy. And who says you need to limit yourself to investing or trying one network or copy trading platform?
Each network has their own pros and cons (see our social trading platform reviews), but also, every platforms attracts different types of traders or systems. Hence diversification between networks may give you additional exposure to different risk profiles.
Open platforms where anyone can become a signal provider will attract on average higher risk traders than actively monitored platforms where traders need to stay between pre-defined risk criteria.
And if you cannot find a number of different traders to invest in, make sure you limit the percentage of your funds you invest in the single trader, so when other interesting traders become available, you have the funds ready to invest in them.
I’m not sure why but for some reason loads of people who invest on social trading networks seem to expect that traders they follow or copy don’t make any losing trades. Let’s be clear, occasional losses are inevitable. In fact I’d even be very suspicious of any trader with a win % higher than 85%.
No one can predict the future and high win rates are only achievable by building up large drawdowns. And we all know what happens in the long run with these types of strategies in the long run (HINT: $0 balance).
Hence if you have done your research correct, you should give the trader at least a reasonable amount of time (3 to 9 months depending on their trading style) to prove themselves. Yes, do monitor, and if their strategy or approach changes then intercept early.
However if you did your research and configured the right risk settings appropriately, then you should be able to cope with some initial losses and they should not impact your balance to the point where you panic or lose your allocation.
Poor Risk Management
Poor risk management can occur at a number of levels and pretty much always leads to large losses.
For starters I’m still surprised that some people start investing money on social trading platforms without knowing the difference between a lot and a mini lot, or what 50×1 leverage is. Each platform normally has sufficient features to manage risk. However if you don’t understand how much your allocation is likely to move on an average trading day, then don’t start.
Most platforms offer a demo account for you to try (at least for limited periods). If you’re not sure then try and follow the demo account’s movements every day to see how your investment can fluctuate.
In social trading profits can rack up exponentially, but losses even more so if a trader goes rogue and keeps adding to losing positions using a Martingale type strategy. If you haven’t limited the maximum capital that trader could lose individually, you’ll likely lose your full account, even if you copy 5 other traders who are doing well.
And how much to invest per trader? It obviously depends on your risk profile, but needless to say that if you throw 50% of your allocation at a single trader (however good they were in the past) you’re left with only half your capital if they lose their account balance or you take too much risk on them.
Every trader or system will also have periods of drawdown … that is inevitable! However plenty investors seem to assume that they’ll hit the jackpot with every trader and start copying them at the beginning of a winning streak.
The risk of drawdown needs to be taken into account individually for each and every trader or system copied. Take input from the trader’s strategy description AND also work it out yourself.
And don’t forget that overall, social trading can be very risky. So never invest money you cannot afford to lose!
As always your comments and experiences welcome below: