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Who are social trading networks for?

By Sheyna Steiner · Bankrate.com
Friday, July 19, 2013
Posted: 6 pm ET

Trading the currency market is a risky and speculative endeavor, but more than a few individuals manage to make money at it. The fact that many more lose lots of money trading the foreign exchange market, or forex, hasn't dissuaded hordes of would-be traders from trying their hand at speculating. In recent years, social trading networks have sprung up across the Internet that capitalize both on the experts who have mastered forex trading and the investors who want to emulate them.

Social trading networks are part message board and part forex broker. Investors can talk to each other, see what other people are trading, and in some cases, pick master traders to observe and copy. The cool part is that with just a click of the mouse, a novice trader can have an expert's trades automatically replicated in his account.

While it sounds like easy money, there are a few things to be aware of before signing up for an account with a social trading network.

There are several social trading networks, some of which are profiled in today's story, "Social investment networks the new craze? "

Your mileage may vary

First of all: Don't fall for the advertising hype. The potential returns promoted in bold print are hypothetical or may be massaged to reflect the company in the best light.

"I always try to advise traders to approach this from a skeptical perspective. You have to do your own due diligence as you would do with any other product and asset class," says Kathy Lien, managing director of BK Asset Management and the author of several books on trading, including the most recent, "The Little Book of Currency Trading."

Relevant trading data may be omitted by some of the sites, which will complicate or negate historical analysis, according to the site SocialTradingGuru.com. For instance, Currensee leaves off the time stamps of the historical trades by trade leaders and also neglects to include the level of leverage used. Experienced traders and those trying to learn the complex ins and outs of forex trading would like that information in order to analyze the strategy, according to the site.

"They don't provide you with all the historical data of all the traders you can copy and follow. You have to trust the results, and you can't replicate them on your own because you don't know when they closed their trade," says Kurt Festraerts, founder of the SocialTradingGuru.com.

Knowing how much leverage traders use is also an important metric for potential followers. Leverage refers to the amount of borrowed money the trader uses. Outsized returns are often achieved by taking outsized risks.

"It's important to understand the leverage ratio that they are using," says Lien. "Oftentimes when you get a portfolio that has 200 or 300 percent returns, that's often a result of significant leverage," she says.

In picking a social trading network, investors should look for transparency and low fees or reasonable spreads.

Of the social investing networks around now, only Currensee charges a monthly maintenance fee. It requires the highest minimum investment amount as well. Unlike other networks, it doesn't offer a demo account that enables you to try out trades with fake money before speculating with real money.

"They try to market themselves as the Rolls-Royce solution of trading networks. You need more money to invest, and they say the traders on their network go through a more formal vetting procedure," says Festraerts.

"In my opinion, from my experience, I wouldn't say that their traders are that much better or different. Do your own research, and be vigilant. You can't assume that they aren't going to take massive amounts of risk," he says.

Investigate the many free message boards and websites devoted to forex trading, and find out what people who have used the sites have to say about them. Pick one network or try several to see which trading platforms work best for you.

Who to copy?

In the end, the traders you pick to follow will be more important to your bottom line than the network they're on. Look for traders with a long history of success and relatively low risk.

"Take a look at how long these traders have been trading," says Lien. "The websites show the win ratio or the return. Take a look at the period of time this return has been generated. Was it one month? In which case, it might be difficult to replicate. Or did they basically build up their account's equity over time with smaller drawdowns?" Lien says.

"Another red flag: If you see a lot of volatility in a trader's portfolio, that screams higher risk. While I do think the sites are interesting, you do have to do your due diligence," she says.

Festraerts agrees. "You want someone with a long trading history. It's easy to find someone who, in a couple of weeks, has made a lot of money. The key is to find someone with a year or couple of years," he says.

Beyond their experience, look for traders with some skin in the game. "Find people who invest with their own money. On some networks, traders send signals or trade with a demo account. When they are taking high risk, they are not taking it with their own money, only the money of the people who follow them," he says.

Even with someone doing your trading, there's no free lunch: Investors should keep an eye on their accounts. Things can go haywire for any number of reasons.

"Sometimes people you follow do very well when the market goes their way, and then it turns and you see them start to panic, and they start doubling up on their losses, adding more and more to their positions until the account runs out. The key is to avoid picking people who end up doing that," says Festraerts.

To avoid falling down that rabbit hole of empty pockets and broken dreams, take your time to learn about the risk management features the sites offer, and learn how to discern the consistently good traders from a flash in the pan. Remember: Even the best traders lose money, so there's no guarantee of positive returns.

Use it as a learning opportunity

Don't sign up for a social trading network in hopes of making easy money. One of biggest perks of the websites may not be quick returns but education. Investors interested in learning about forex trading can get a front row seat on the way experienced traders work.

"You can sort through and see who the best performers are. You can look beneath the hood and see whether they are short-term traders, long-term traders and the risk profile they take. So I think there's a good opportunity to learn more about (forex) trading in general from these different services," Lien says.

It does require a certain level of expertise. You have to know a little about forex to make sense of everything and to sort through the strategies and trading styles. Rather than expecting easy money, expect to do a lot of work and learning.

"It's not as simple as picking someone based on the amount of money they have made over two, three or four months; you have to know how much they were risking as well," Festraerts says.

Spend a lot of time learning the ropes, and make sure you understand the information the network provides. Most forex brokers offer paper trading or demo accounts to practice trading, and most of the social trading networks do as well.

Once you're ready to get to it, Lien recommends using caution.

"Once you feel comfortable, start small. There are many different trade sizes that you can use in (forex) trading -- anywhere from 1,000 units to whatever your account can afford. You can have the psychological impact of using real money but without putting a large amount of capital at risk. Take advantage of all the resources that brokers offer, including education and research," she says.

Do you plan on trying a social trading network?

Follow me on Twitter: @SheynaSteiner.

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Senior investing reporter Sheyna Steiner is a co-author of "Future Millionaires' Guidebook," an e-book written by Bankrate editors and reporters. It's available at all the major e-book retailers.

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