Virtual currencies are highly volatile. Your capital is at risk.
The software platform, eToro pioneered and popularized the concept of social trading when it introduced its Open Book social trading platform in 2010 with its key feature of “copy-trading.” This innovation at the intersection between social networking and financial trading has opened up new and profitable ways for people to invest in both traditional financial markets and crypto assets.
Social trading, much like social media, is made possible by the immediate communication and interconnectivity of the internet. By being able to share and spread information to a wide group of people for very little or no cost, people on these platforms are able to act and make decisions as groups instead of individually. Social trading takes this idea of group sharing and decision making and applies it to financial trading and investing.
Essentially, social trading allows users to observe the trading decisions of the other traders on the network and then decide whether or not they want to copy their trading strategies. These networks include the entire spectrum of traders from complete beginners to experienced experts and professionals. The logic is that the less experienced or confident traders will copy the more proven and successful traders.
This method of investing is known as copy trading or mirror trading. For every trade that the copied investor makes, the platform automatically performs that same action on the copying investor’s behalf.
Beyond simply copying or mirroring trades, social trading allows unprecedented access to decisions and information that was before either highly guarded or only available to the privileged few who could afford to hire traditional wealth managers. With the barriers to entry dramatically lowered, social traders are able to join in on effective investment strategies with much less knowledge, experience, and costs than ever before.
The World Economic Forum noted social trading as a key disruptive trend in its “Future of Financial Services” report, categorizing it as one of the major innovations that are empowering investors.
The report highlighted how more retail or casual investors are gaining access to sophisticated and powerful wealth management products that were traditionally only available to institutional investors.
Wisdom of the Crowd
The first major difference between traditional trading and social trading is that the barriers to entry and success have become much lower. In the traditional investing world, many years of experience were needed to develop effective trading strategies and techniques. In contrast, very little experience or skills are necessary to get started when joining a social investing network.
The skill that is important is not in deciding which assets to invest in and at what time to invest, but which trader to copy and when. Deciding which investors to copy means relying on cues from the other users on the platform as well as making judgments about how an investor will perform based on their track record.
Popular investors who have a higher or more active following will likely find it easier to gain new followers or copiers. The larger and increasing numbers of participants in the group are likely to increase the richness and variety of information sharing, discussions, and interactions surrounding that particular investor. This reliance on group knowledge is referred to as the “wisdom of the crowd” and is a fundamental benefit of social trading.
According to research by Yaniv Altshuler from the MIT media lab, the crowd makes better investment decisions than individuals. After looking at data from over 5.8 million trades on eToro from August 2010 to January 2012, the report found that one of the best and most profitable strategies was for users to mirror other traders’ strategies.
In the context of this report, mirror trading means that “for every trade the example user makes, eToro automatically executes the same trade on behalf of the user.”
The second major benefit from social trading is that traders no longer have to compete against each other in order to profit. They have more to gain from cooperating and collaborating as a network. This means that pooling and sharing resources such as funds and information will benefit the group as a whole.
As a result of a more collaborative form of trading, investors are more willing and even incentivized to share as much information and research as possible. Users of social trading platforms willingly have their entire history and statistics open to scrutiny by their fellow users.
This information includes past performance statistics, trading strategies, decisions, and asset allocations. The transparency with other users means that traders have more honest information available to them, which in theory should lead to better decisions.
Since copy trading is a type of automated investment strategy, there is naturally a reduction of emotions associated with each financial decision. Since it’s all done on autopilot there is less temptation to change your mind or make a decision out of an emotional reaction.
Fear, greed, and confidence or lack of confidence can all have a dramatic impact on an investor’s decisions and using a mirror trading strategy takes some of those emotions out of the equation, which is especially helpful to new traders.
Simply because there is a new financial innovation does not mean that there are no risks involved. The risks are simply reallocated to another form of decision making. Instead of having to rely on knowledge about specific market trends and coming up with accurate predictions, users now have to decide on which investor can do that best and how much to invest in them.
Past performance is not an indication of future results
As indicated on eToro’s homepage and immediately referenced by most articles, websites, and podcasts that deal with financial investment is the truism; “past performance is not an indication of future results.” Investing is essentially a game of risk management and probabilities in the face of uncertainty.
There are no guarantees that an investor who made money in the past will continue making money in the future. This makes copy trading especially risky because a trader who performed phenomenally in the past may suddenly lose their flair, which leaves you, the copy trader, at a loss.
And this happens more than you would think mostly because of lucky trades.
Some investors may have just been lucky in the past. They may have invested at a good time while the market was going up and got caught up in a positive trend. If an investor simply got lucky then it cannot be attributed to skills and experience that got them their positive returns so they will be unlikely to repeat their results in more adverse circumstances.
The best example of this was in the crypto bull market of 2017 and the subsequent bear market of 2018. In 2017, the entire crypto market rose dramatically with Bitcoin rising from below $1000 on 1 January 2017 to nearly $20,000 before the year was over with nearly all other major crypto assets following similar trajectories. If you made the decision to invest in crypto assets at the beginning of 2017, were you smart or were you just lucky?
Many people were simply there at the right time, however some people really had a vision for the future.
Nearly the exact opposite happened in 2018 when Bitcoin dropped from its height of over $17,000 down to under $4,000 per Bitcoin. The rest of the crypto market followed this downward trend usually with more severe drops than Bitcoin. A lot of people made a fortune only to completely lose it when the bubble burst.
If you made the same investment at the beginning of 2018 it would have a very different result than if you had made that investment in 2017. Were you stupid or just unlucky?
With copy trading, the role of luck becomes even more unclear because investors are placing their trust in others. If investors were still making trades like an individual, at least they can be honest with themselves about whether they were smart or just got lucky.
A common investment strategy in the crypto space is to HODL. The misspelling has come to mean “Holding On for Dear Life” and was born from the wild volatility that is common in the crypto space, but not in other traditional investments.
The HODL strategy simply means holding on to a coin or token such as Bitcoin for as long as possible because fluctuations are temporary and in the long term, the value of a crypto asset like Bitcoin will rise exponentially. This passive and long term investment strategy is counter to what eToro is offering, which is a way to profit from frequent trading activity.
The pioneer and leader in the social trading space is eToro. The company was founded in 2007 with the mission “to make trading accessible to anyone, anywhere, and reduce dependency on traditional financial institutions.”
The eToro main office is located in Israel with registered offices in the UK, China, Australia, and Cyprus and its services are available in over 140 countries. eToro’s main innovation of social investing came with its OpenBook social trading platform, which included the CopyTrader feature.
Range of Products
The platform started offering Bitcoin trading in 2013 and introduced other cryptocurrencies such as Ethereum, Ripple’s XRP, and Litecoin in 2017. Besides its social trading platform, eToro stands out from other cryptocurrency exchanges like Binance & Coinbase etc. because it offers a wide range of financial products to trade beyond crypto assets such as stocks, ETFs, currencies, commodities, and indices. In this guide, we will focus solely on its crypto products.
eToro currently offers 15 of the top valued and most recognized crypto assets:
Since eToro is a centralized platform, buying crypto assets on its platform means that eToro is purchasing the crypto asset and holding it on your behalf. Because crypto assets are unregulated, there is no investor protection unlike with its other more traditional financial products.
eToro even has its own mobile crypto wallet, which is specifically designed to manage crypto assets. Users of the platform can only transfer Bitcoin, XRP, and Ether to their eToro mobile wallet from their normal eToro account, but are not allowed to transfer them back from the wallet.
However, more crypto assets are available directly on the eToro wallet and can be purchased using GBP and Euros, but not USD. Unlike other crypto wallets, which we’ve reviewed on blokt, the eToro wallet is quite limited and meant to be more of a companion to the eToro platform than a standalone product.
One of eToro’s chief products is its CopyPortfolios, which allows users to bundle together different types of assets that are managed by eToro’s professional investors. These portfolios can be characterized by a range of different markets or strategies.
For example, the Active Traders CopyPortfolio uses an algorithm to select a large number of active traders with the best records. The OutSmartNSDQ CopyPortfolio combines artificial intelligence and the wisdom of the crowd to select the 15 Nasdaq stocks that have the most positive investor sentiment.
Within these CopyPortfolios are fully managed crypto focused portfolios with different strategies and asset allocations. Because of the bear market in crypto assets that started in 2018, these crypto focused portfolios are down significantly in the last 12 months and are characterized with a higher risk than other eToro CopyPortfolios.
The most popular crypto-focused portfolio is called CryptoPortfolio, which is a CopyPortfolio managed by eToro’s digital asset allocation strategy. You can easily see important information about each portfolio before you invest such as their exact asset allocation, past performance, and the number of investors.
The CopyTrader function is eToro’s landmark innovation and is at the root of social investing. Investors with little or no experience are able to take advantage of the strategies employed by more experienced traders by automatically copying their moves. Professionals and amateurs can thus work together to share information and try to be successful.
How it works is you pick an investor that you want to copy based on their profile, record, stats, amount of copiers, etc and then allocate some of your assets to automatically mimicking that person’s portfolio and investment decisions. You can allocate as much or as little of your total assets as you want in as many or as few investors as you want. Because of regulations, copy trading is currently not available for US residents.
The Popular Investor program is an opportunity for experienced or professional traders to earn income on top of their trade gains. It is the supply side of copy trading. Popular Investors on eToro can earn a 2% annual fee for the total amount that other traders allocate to copying them. This fee incentivizes successful investors to use the eToro platform by giving them an extra income stream for work that they are already doing.
Though eToro is the biggest and most popular social trading platform that offers crypto assets, there are others which have emerged. ZuluTrade is similar to eToro in that it offers a variety of assets to trade along with crypto assets such as stocks and fiat currencies. NAGA also offers a wide variety of different assets but is unique in that it also has a native crypto token called NAGA Coin. CopyMe.io and Covesting.io specifically focus on social investing for crypto assets.
Registering on to the eToro platform is fairly standard for a financial trading website. You must enter the usual information such as your name, address, phone number, email, and social security number if you are a US citizen.
Once you sign up to eToro, the first thing you will notice is the watchlist, which is a customizable dashboard that shows the stocks, currencies, crypto assets, and investors that you want to follow. We will focus solely on crypto assets and crypto traders for this walkthrough.
The eToro platform has many similarities to a social network. It has a general newsfeed for all the markets and people that you follow and a more detailed newsfeed for specific markets. There’s also a way to post that is similar to something like Twitter with tags for @People and $Markets.
There is a virtual portfolio option for users to play with imaginary money before investing the real thing. The virtual portfolio allows users to test features and strategies as well as invest virtual money in different CopyPortfolios or traders to see how everything functions. The portfolio shows your assets under management and how they are allocated as well as the profit or losses:
The ability to copy other traders is eToro’s main differentiating function so we will go through exactly how it all works using our virtual portfolio. We will look solely at traders on eToro who have crypto in their portfolios.
You can browse and narrow down which investors you want to copy according to different categories or filters. We will be looking for traders who are in the crypto market, have returns of greater than 15% in the current year, and have more than 500 copiers.
Using the criteria above, we narrowed down our total investors to only 12. We are going to select the top 5 investors to copy by ranking them by the number of copiers and by highest return.
There is some overlap between the two rankings with 3 investors being in the top 5 of both. Using our virtual portfolio, we will copy the 7 investors that appear on our 2 lists; investing $10,000 of our virtual money in each of the investors that we have selected.
Like other social media platforms, eToro allows traders to make posts to their followers, discuss ideas, and share predictions. This direct interaction between investors and copiers builds trust and gives people a glimpse into a trader’s personality and trading philosophy. The transparency also further cultivates a more collaborative trading environment.
Before deciding on whether to trust an investor and copy his or her moves, you can view past statistics about that investor’s results and actions. You can also see which trades they’ve made in what type of assets as well as how profitable those trades were.
Users can also see how much of a trader’s investments are in crypto or other types of assets. There were very few traders that had more than 50% of their assets allocated in crypto as well as over 10% returns in the current year and a good following. This should not be surprising considering the crypto bear market that we are still in. Good traders know to diversify and invest in uncorrelated assets as a way to defend their positions.
When you choose to copy a trader, you will also be given options to stop copying that trader at a certain point, which you can customize. This stop copying option limits your losses in case an investor makes some trades that result in heavy losses.
We can see all the people that we are copying and the allocation of our assets, which are now equally distributed to the copied traders.
Two days after deciding to copy these 7 investors and allocating $70,000 equally across each of them, I have made a profit of $1000. Most of the traders that I’ve copied are up so it seems like I made good choices at the moment. Obviously, this can change any day and I was fortunate to make the investments at a time when the crypto markets were rising.
Set It and Forget It?
This method of copy trading is a good way to forget your troubles and relieve the anxiety that is inherent in financial investing. Decisions are made for you by more experienced investors who also have their own money and reputation at risk.
Despite this relief, there are still decisions that need to be made such as how long you want to keep investing in these traders. At some point, you might want to change your allocation or stop investing in them completely.
Social trading gives regular investors a new, low cost, and easy tool in the highly competitive financial markets. It allows people to access the wisdom of the crowd, transparent information, and a collaborative trading environment. Hopefully, this means higher returns for more people including you.