The Internet revolutionized trading in the '90s with online trading platforms. Suddenly, everyone could open a brokerage account and trade at any time without calling anybody or sitting through a sales pitch. A decade later, the hive mind of the Internet is buzzing around the idea of social networking for investors.
Several big social investment networks already exist, and more are emerging every day. Investors can message each other and read what others say about trading and investments, but that's nothing new. There are countless free message boards and forums available for those sorts of services. The hook of social investment networks is the ability to link your account to other traders and have their trades quickly replicated in your account automatically.
It sounds like a great deal -- but keep in mind a lot can go wrong when making speculative trades using leverage. Trusting other people to decide how you should trade adds another level of risk to an already uncertain endeavor. Market and trading risk aren't the only hurdles on the way toward profits; fees could definitely eat into any possible returns. Just so you know: Bankrate doesn't endorse any of these companies. Social investing networks could be the wave of the future -- or they could be a new-fangled way to lose lots of money.
Trading in the 21st century
Though many social investing sites trade the foreign exchange market, or forex, some sites do offer the ability to buy stocks and other investments, and they let investors follow and automatically copy the trades of stock, futures and options traders.
The sales pitch essentially says investors no longer need to pick winning investments; they can just copy the trades of people with a history of winning and reap the rewards. But there are a couple of catches. First, buyer beware: Past performance is no indication of future returns. Investors should always do their homework and understand what they're investing in.
Second, these social investment networks generally charge fees. Can individual investors generate enough returns to outstrip the costs of trading? Maybe, but while profits are only hypothetical, fees are certain.
"Large costs associated with the services themselves should definitely be the major concern for the investors. One must try the paper-trading accounts for as long as possible and not follow those traders which trade a lot, as this will result in a lot of commissions for the trades executed," says Arseniy Korobchenko, director of marketing at On Budget and Time Ltd., a financial technology consulting firm.
Paper-trading accounts are just like real accounts -- but with fake money. The demo accounts let investors test the waters before committing real funds.
That's important because forex brokers are very willing to lend money for trading, enabling investors to use leverage, which amplifies returns as well as losses.
Beware of borrowing
Leverage is a double-edged sword. Investors can risk less of their own money upfront but could incur big losses if their trade ends up losing lots of the money they've borrowed.
"The problem with forex is that it is highly leveraged. When you buy 100 shares of IBM for $10,000, you either put up the money or buy it on margin," says Tim LuCarelli, chief analyst of FXAddicts.com.
By buying on margin, an investor would put up part of the cost to purchase the security and borrow the rest. It's the same in forex trading, but more widespread.
"It is a way of getting more meaningful trading results from forex's low volatility by making forex trading available to users that wouldn't have such an opportunity to trade without it," says George Kollias, publishing director at ZuluTrade.
Investors may be lured in by the thought of easy money, but that street goes both ways: Losing it can be just as easy.
Each social investment network does things a little bit differently, but the basic idea is that investors can interact with one another, peruse news and research, see other people's trades, and pick traders they want to copy.
The fees vary from site to site, as do the ways trade leaders are chosen. On some sites, the leaders apply and go through a vetting process. At least one site, Collective2, allows anyone to set themselves up as a leader, and natural selection takes its course: If they do poorly, they will fall down in the rankings, and no one will follow them.