Every technological innovation comes with its own accidents and variants. When social media became a “thing”–that is, a way for people to virtually gather and be with one another, it also paved the way for virtual and “real” forms of resistance–fueling protests, riots, and even “cancel culture.”
Enter “social trading.” Look it up and you’ll find the more standard definition which is a method of investing in which some investors use social media platforms to follow the opinions, recommendations, or trades of fellow investors or industry experts.
It’s not unlike the typical herd mentality of trading based on what others might be thinking. The difference is that such thinking can be coordinated in real time, What you end up getting is a swarm. We saw that with the sub-Reddit chatroom Wallstreetbets and its effect on GameStop, AMC, and the silver short squeeze in late January.
Some people made a lot of money. Some people lost a lot of money. People who have an eye on particular markets and enough know-how to take advantage of such swarms might have fared better than others. This post is about the latter–those who aren’t in a position to skillfully navigate such information.
Here are three risks that traders may encounter when following a social media chatroom. We’re not saying that there isn’t any value to following social trading chat rooms. We just want to emphasize that you should be aware of the risks before you trade based on their recommendations.
1 – Once the rumor gains steam, it might be too late
The Gamestop short-squeeze raid began when shares were trading under $40 per share. The swarming took place anywhere from $40 to over $300 per share. You can imagine that many who came late got burned. Here’s the difficulty in such a situation. If it’s rumored that people are about to pile into a given asset, it can’t be confirmed once it takes off. But if you jump in once it takes off, there’s the likelihood that you may be too late. The problem is that there are likely plenty of “signals” given across a wide array of instruments. Which one’s should you target? Unless you understand that particular market, sector, industry, or asset, you’re taking chances without fully understanding the probability of your trade.
2 – If someone gives you a fish, you may never learn to fish yourself
The most successful traders and investors didn’t sacrifice “craft” for “crowd.” They didn’t rely on others’ opinions without having an opinion of their own. If you rely solely on a trading signal, you may never develop the necessary skills to become a self-reliant trader or investor. There isn’t always safety in numbers, particularly when a herd rushes off a cliff. What matters is not what the crowd sees, but rather, what they don’t see. You have to know when to follow the crowd, when to trade against the crowd, or when to simply stand aside.
3 – If you’re following an “expert,” you may be the one making that expert wealthy
How do you know if the expert giving signals is actually participating in the same trade? What if that expert is looking to take the other side of the trade? What if that expert is making money in subscription fees rather than through trading? There are plenty of unknowns here, and if you can’t assess the market on your own terms, you’re leaving yourself vulnerable. In this case you might be better off investing in an active fund where a manager’s actions are more transparent and regulated. Trusting an expert is risky if you have no way of assessing that expert’s true positions, qualifications, or intentions.
The Bottom Line
Social trading does have its benefits–namely, calling your attention to a range of market opportunities of which you may not be aware. The financial markets encompass a massive global span of smaller markets containing thousands of financial instruments. Not one person can keep track of everything that’s going on. And that’s the value of following a good social trading platform. But if you do not have the necessary skills to distinguish potentially favorable and unfavorable opportunities and risks, then you may be rolling the dice every time you trade. And remember, there’s a big difference between taking a calculated risk and partaking in a gamble.
Please be aware that the content of this blog is based upon the opinions and research of GFF Brokers and its staff and should not be treated as trade recommendations. There is a substantial risk of loss in trading futures, options and forex. Past performance is not necessarily indicative of future results.