To understand how really Social Trading works you should first know the key players who take part in this big machine.
Forex Market, the Social Trading’s home
The Forex Market it’s by far the largest market in the world for the daily trading volumes. Any other market in the world don’t even get to half the size of Forex.
In this market you trade money, or rather currency pairs. A currency, such as the dollar, is never bought or sold in absolute terms, but always in relation to another currency. So, if I want to buy dollars I must, for example, sell the euros I possess, and to determine how many dollars I will receive I have to use the euro-dollar exchange, or EUR/USD. This change increases or decreases depending of the increasing or decreasing of demand and supply of the two currencies.
In the Forex market you can invest and make trading (or even better Social Trading) on the increase or decrease in the currencies exchange rate. As they say in the industry, if you buy EUR/USD, or “you go Long” on EUR/USD (buy euro and sell dollars), you want the exchange to increases in value, so to profit from the difference. Conversely, if you sell EUR/USD, or “you go Short” on EUR/USD (sell euro and buy dollars), you want the exchange to do gown to earn the difference.
How much this difference is worth depends on the PIP, which is the measurement unit of exchange rates. Usually, the pip is the minimum deviation of the fourth decimal place after the decimal point (ex. if EUR/USD rose from 1.3000 to 1.3001 it’s increased by one pip).
Forex market is now very well-known because, thanks to the expansion and explosion of technology and connectivity, the costs and the tools to be able to participate, including Social Trading itself, have become really affordable for everyone.
Moreover, in recent years, thanks to the technology of CFD (Contracts for Difference) some companies, eToro above all, are opening Social Trading up also to the stock market, indices and commodities.
The broker, your travel companion
The broker is the one that allows anyone who wishes to participate in the Forex market to make trading operations, with extreme speed and comfort.
To contact a broker you can use your phone as it was once, your computer as is done now, or even a Social Trading platform as you will be able to do in a short time.
The broker is nothing more than a middleman that stands between you and the market itself.
Let’s suppose you want to go Long on EUR/USD, ie you want to sell your dollars and buy the euro, because you have the intuition that euro will rise in value.
At that point you just have to contact your broker and ask him to buy euros and sell dollars on your behalf, using the money you have deposit into a special trading account. You will give instructions on the amount you want to trade and the broker will take care of all the rest. Same thing when you will want to close the transaction by selling the euros and buying back the dollars.
Everything is always moving through the assistance of brokers. Social Trading makes no exception.
The Retail Trader (or Signal Provider or Guru)
The trader is nothing more than a person who just trade on a market.
Trading on the markets means making transactions with a certain type of goods, with the intention of making a gain from changes in the prices of these goods, provided of course that the change was in the direction the trader had hoped.
As already mentioned, in Forex the trades are done on the variation of currencies exchange rates, and with CFDs a trader can do the same thing with the price of single listed shares, indices or commodities.
There are different types of traders, those who make trading for institutions, or those who do it for large private companies. Those instead that trade by their own and in absolute autonomy are called Retail Trader, and they work on the markets with the help of a broker, as we have seen before.
Usually (but not always) a trader is an experienced person, who has studied the market structure, its characteristics and its functioning. With this supporting knowledge, the trader identifies the favorable periods for taking actions, ie for executing his trading operations.
The methods, techniques and strategies that traders use today are as many as the languages and dialects in the world.
There are those who only rely on the study of macro-economic data in order to understand global trends and to make long-term transactions. There are those who exclusively uses technical analysis tools, thanks to computerized platforms, to make short, medium or long term operations, regardless of the macro economic data. There are those who do a bit of both things.
There are also those who, using computer, create programs that open operations on their behalf, at the occurrence of certain specific conditions on the price performance, even without the trader’s intervention.
When we refer to a retail trader in the world of Social Trading, is preferable to call him “Signal Provider“, but every company then tends to call its own retail traders in its own way. For example eToro until recently used to call them “Guru”, while now they are simply “Investors“.
The investor (or follower)
This is the role you will have.
In the great Social Trading machine, the investor is the one who has chosen to receive the indications of opening or closing certain trades, on certain exchange rates, directly from one or more retail traders previously chosen.
What does it mean?
It means that if you choose a trader, or as he’s better called a Signal Provider, every time that Signal Provider will open an operation on his personal trading account, the same type of operation will also be opened automatically on your trading account, thanks precisely to the Social Trading process.
Identical process when he will decide to close it. If the operation of the trader will made a profit, also your operation will made a profit. Same thing for the losses. Nothing could be simpler.
When referring to an investor in the world of Social Trading we can also call him “Follower“, especially in the case of ZuluTrade.
The Social Trading company
Who makes this magic happen is the Social Trading company.
These companies are concerned, ultimately, with putting in communication respectively the brokers of the Signal Provider with those of the investors.
In practice, the company makes a deal, on one side, with the Signal Provider’s broker, agreeing that whenever the trader makes an operations, that must be immediately communicated to the Social Trading company. On the other side the company agree with the follower investor’s broker that the buy and sell orders on that client’s account will arrive from the Social Trading company itself.
When an operation will be performed by the Signal Provider, the company will pick it up and will turn it respectively to all the brokers of the investors who had decided to follow that trader. Any broker, once received the order, will execute it immediately on the user’s account, according to the details contained in the order.
Another model is instead that proposed by eToro. This company does not connects brokers of traders and investors. EToro is itself a broker in all respects, and its customers have opened an account directly with this company. The trades replication process is basically the same, but everything is handled internally.
And that’s the identity of the participants in the largest market in the world, through the most innovative investment technique, that is Social Trading.
In the next lesson we’ll show you how this replication procedure is carried out in details.