Social trading has become one of the most recent modernizations within the intercept between financial applications and information technology since the financial crisis. Social trading platforms allow their traders to manually or automatically duplicate the trading strategies of other investors. Traders can observe trades that other investors have executed on the platform and copy those trades that capture their interest. Therefore, social trading platform providers enable investors to act on these platforms in two different ways:
- They can choose to make their investments publicly available and allow other investors, signal followers, to copy their investment strategies, thereby acting as signal providers.
- They can choose to act as signal followers and reproduce other investors' investment strategies.
The data is obtained from one of the largest social trading platforms in Germany.
The study examines if it pays off for signal followers to copy investment strategies undertaken by signal providers. Thereby, it is analyzed if social trading investors are skilled in the sense that they are able to cover the costs related to their investments. For this purpose, a proprietary data set of one of the largest German social trading platforms, namely ayondo, is investigated. Using this platform, investors can trade CFDs for a number of instruments by establishing long and short positions. For the detection of skill among the investors, a bootstrap analysis is used as it allows differentiating between skilled and unskilled investors.
Investing in signal providers should be done with care.
The results show that in the aggregate, social trading investors perform significantly negative when accounting for the investment costs of signal followers. Considering these costs, all signal providers until and including the 70th percentile are not able to obtain positive returns. Still, the model also detects some social trading investors that have sufficient skills to consistently cover their costs and even to achieve positive returns. Therefore, the study illustrates that investing in signal providers should be done with care, still it could benefit some signal followers.
Social trading platforms should extend the entry barriers for investors.
The study raises concerns for social trading platforms, as it demonstrates that in the aggregate, selecting the wrong signal providers could result in severe losses. Social trading platforms should think of ways to enlarge the entry barriers for social trading investors. By doing so, they would raise the skill level of signal providers on their platform. Moreover, this raise of skill could be a good incentive for further signal followers to join the platform. As of now, however, signal followers need to be very careful when choosing signal providers or even further, they should not invest their money on social trading platforms at all when they are not able to detect skill.
In summary, the study shows that the majority of signal providers does not generate positive net returns for signal followers. Therefore, signal followers should be very cautious when investing their money on social trading platforms.
Please refer to the original paper for further details: