The risk factor in Social Trading
Like any type of investment instrument, Social Trading also has a certain amount of risk.
Each Signal Provider category has some parameter characteristics of strengths and, of course, of weaknesses. In this chapter, we will concentrate on the latter.
In addition, a Signal Provider’s operation is not the only risk-carrier, but there are others too. However, don’t worry. Once you will know it, it will no longer be risk, but only another element of the puzzle, to be considered together with all the others.
Risk with a long term Signal Provider
Rather than risk, for a followers investor who decides to use this kind of Signal Provider, we should talk about the need to have the right mindset.
The problem, if you choose to set up a long-term strategy, is that most likely, for a long initial period, you won’t see any particular profits, but rather small losses.
In general, Signal Providers who seriously use long term techniques are the least risky among all, because they never leave losses to run, but instead they cut them trying instead to let profits run. It won’t be an immediate process, and many losses will be cut before you see some nice profits exploding into your account.
For many followers investors this can be a problem because they may think they have made the wrong choice, and they may leave the Signal Provider without giving him enough time to express its potential, perhaps missing an important opportunity.
The Long Term Signal Provider, therefore, are not good for those who cannot wait. However, as said many times in the first investing course, the ability to manage risk, and so to be able to wait and have the right patient, is one, if not the most important, among the qualities that a good investor should have.
Risk with a day trader Signal Provider
As mentioned for the Long Term, even for Day Trading Signal Providers we don’t properly speak of risk, but rather of right mindset.
If for the Long Term you could see a long series of small losses before seeing a profit explosion, with Day Trading you could encounter some series of losses and profits very similar to each other, before seeing a real and permanent capital increase.
In other words, in the day trading techniques is very common, for certain periods, for profits and losses to be equivalent, and that the account balance continues to rebound without rising, remaining fairly stable, or maybe down a little bit.
Again, it’s just a matter of having patience in the strategy of the Signal Providers you have previously analyzed. If his modus operandi has not changed, it probably means his strategy is going through a non-convenient cycle, but that, given the statistics on which it was founded, sooner or later it will come back to bring new profit to the capital.
It’s all about controlling risk and have the right patient.
Risk with a swing trading Signal Provider
This category, as always, is a little bit half-way between the long-term trend follower and the day traders.
As with the long term, there may be several attempts to catch the swing ending with stop loss. As with day trading, profit and loss (although the extent of profits is usually much greater than the losses) may be equivalent, or lead to meager gains even for long periods. So, here also you need a good dose of patience and acceptance of the strategy.
Risk with a scalper Signal Provider
From the scalping category onwards, we can rather talk about real risk.
The main problem in applying such a strategy lies mainly in the slippage. As you know, the slippage is that very small difference between the price at which the Signal Provider’s trade was executed with respect to the price at which the follower’s trade was executed on his account.
It’s a very small difference, often against you, caused by the inevitable passage of time, although very short, during the replication process, and by the small price differences that may exist between different brokers.
With a Scalper Signal Provider you will have a huge amount of replicated trade, each one with its intrinsic level of slippage. Considering that the profit margins of Scalpers are very tight, even in the order of less than ten pips or just a couple of pips, if moreover you’ll have to to subtract each time the slippage, you run a real risk of compromising the strategy’s performance.
For this reason, extreme scalping strategies must be avoided in order not to see the potential gains eroded by the multiplication of slippage without brakes.
Should be further noted that some Social Trading company make sure to not allow Signal Providers to use extreme scalping strategies.
Risk with a martingale Signal Provider
In no uncertain terms, for us these are the most risky of all.
But we must also recognize that, to an inexpert eye, they are the most attractive, and it is here that the trap can be triggered.
By not accounting their losses, they are the only traders that, for several days, even in a constant way, could give you only profits. In addition, since the losses are recorded rarely, you will often find them in the top positions of the Signal Provider’s ranking proposed by the Social Trading companies.
As mentioned before, the methodical willingness to not cut losses is the most risky thing you can do in trading and investing in general. On the other hand, it’s also true that such a technique, very often, could prevent to account a loss when the price takes another direction. It just takes to wait a few days, and the martingale takes its course, quickly recovering all the losses in order to save the situation and return at break even, maybe even with a small gain.
The problem is that this does not always happen. As said and repeated many times, the market, despite all the statistics a person can study, is an irrational creature. There will be times, and you can bet that sooner or later they will come, when the price will not retrace his steps, even after weeks, running violently in the opposite direction than desired.
While increasing the trades number allows you to recover quickly, I’s also true that, in a situation in which the price won’t come back, that high number of losing trade will dramatically increase the risk due to the level of overall losses.
If you are not sufficiently prepared, these situations can be fatal for your account.
The commissions risk
Up to now we have seen the psychological or technical risk of following one of these Signal Provider categories. Now is time to speak of another possible risk, which can be found in all the Signal Provider categories seen so far, but that affects the most the scalping and martingale Signal Providers.
To let you understand, I have to, first of all, explain in detail how usually a Signal Provider gains sharing his signals through a Social Trading’s company.
For sure you remember, from the lesson in Forex course, that when you open and close a trade via a broker, every time he makes us pay a spread, which is calculated by simply adding a small amount to the real market spread. In the case of Forex, usually the broker adds about 1 to 3 pips as spread, but this can vary both for the broker, or for the currency pairs taken into account.
In any case, the spread is the profit that the broker puts in his pocket every time you open and close a trade. Regardless of whether your trade has gained or lost, you always pay the spread.
In Social Trading the earnings, both for the company and for the Signal Provider, derive precisely from that spread.
In practice, when a follower connect his account to the Social Trading company, this company contacts the follower’s broker, and an agreement is signed. This agreement usually concerns the operations that will be open on the follower’s account.
All the spreads the broker will earn depend on the fact that his client is following the Signal Provider via the Social Trading Company. The broker therefore agrees to pay the Social Trading company a part of the spread paid by the follower in every transaction, in the form of commissions. The Social Trading company, in turn, will correspond a part of the spread to the Signal Provider that generated the signal.
I’m sure that now everything starts to be clear. We can now make two observations:
- A Signal Provider gains if and only if he’s followed by follower investors with a live account, with real money. All those who follow him with demo account won’t make him earn anything
- The more operations a Signal Provider open, the more fees he collects, regardless of whether his operations made the followers gain or not. The spread is always paid.
It’s obvious that, given these conditions, many presumed traders are not landed in the Social Trading circuit to share their experience and, at the same time, to earn some extra money, but rather to gain only thanks to the fees, even though they knew very little or nothing about trading.
Now you understand why especially Scalper and Martingale are a high risk from this point of view, in particular martingale. Many of these alleged traders rely on this rather simple mathematical procedure, which in the short term can yield excellent and very attractive performance to the inexperienced follower.
Imagine. A very high percentage, or even the 100%, of profit trades. Almost no losse. Steady profits every day. This may sound a dream, and in fact it’s just that, a dream, or rather a mirage.
Many followers investors, who have tried Social Trading without any knowledge and experience, have come across these sharks. You can imagine how it ended for almost all of them. A very brief period of happiness before the great sword scythe their accounts.
The hard Social Trading truth
Your legitimate consideration may be “But, by doing so these Signal Provider will also risk their own money. While they earn commissions, on the other hand they will lose their capital.”
Let me reveal the last piece to make you fully understand the risk of those who make Social Trading only for the commissions: in some cases, (not always and not with everyone) the Signal Provider can operate and send his signals even from a demo account.
That’s right, from an account with virtual money, so without risking anything of his own capital. Of course, the Social Trading company will highlight this factor, and it will be definitely something to keep in mind when you will do your evaluations.
Moreover, even in the case of companies that do not allow Signal Providers to use demo accounts, but only real accounts with their own money in, the risks are not entirely eliminated. Thanks to leverage and the new usable quantities (once there was only the standard lot, now there are also mini, micro and nano lots, that are 1/10, 1/100 and 1/1000 of a lot) a Signal Provider can open an account with a few hundred dollars and still have a high level of margin to be able to use these risky techniques. If all goes well, the profits from commissions could be very high, while in the event of a failure, their loss would be only on the small open account.
I won’t deny that this kind of alleged Signal Providers still exist today, and that many novice investors still eventually fall into these traps.
Now, however, this is no longer your problem.
With what you’ve learned, and what you still have to learn with Investingoal, you’ll discover how to recognize and avoid these risks with no difficulty, going rather to find and appreciate those traders who work seriously and professionally, for the common benefit of Signal Providers and follower investors.
Our common mission
Let me add one more very important thing.
Now that you know how this mechanism works, and what is the risk for an inexperienced investor, it’s your duty to make sure that as many people as possible will know how to defend themselves. One of the most ambitious Investingoal’s goal is to be able to make aware of these risks anyone who wants to try, or is already using, Social Trading, and ensure that all the sharks chasing commissions will die of starvation.
Only then can we have a clean Social Trading, really founded on knowledge and professionalism.
There’s an easy way for you to be able to do this. Continue your journey with Investingoal, share our content with your social networks, and above all, join our community in order to make it grow.
This will ensure that more and more investors will come on Investingoal and will find out how to protect themselves. We, of course, we will be happy for obvious reasons, but I think you will be too, because you would have done the right thing.
Because of you, those who will arrive will be able to save themselves from the possible dangers. At the bottom, of the spirit of a community is just that.
Protecting ourselves together from the risks, and sharing together all the benefits.
SOCIAL TRADING COURSE
The Key Players
The signals replication process
Being a Signal Provider
Being a Follower
Signal Providers characteristics
Signal Provider categories
The Risk factor
Equity Line and Drawdown
Money Management principles
Ready, set, go! Invest!