The Problem With Social Trading and Blindly Following

I recently came across a brokerage (I won’t mention which one) which markets itself as a social trading platform. A social trading platform is a brokerage that makes it easy for investors to follow what other users are doing - what they are buying and selling for their portfolios, how much cash they are holding, and so on.

The idea is that rather than venturing out into the big bad world all by themselves, a novice investor can just mimic the trades being made by people with successful track records. This particular brokerage actually offers incentives for investors to become "influencers" - the bigger a following you have, and the more "assets under management" you have, the more money you make.

Now, while this may at first glance sound like a sound idea designed to flatten the learning curve, I believe it is a dangerous system that encourages bad habits in investors. Here’s why.

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The immediate problem that I see with this kind of system is that it doesn’t really flatten out the learning curve - it just makes it seem like it is flatter. This is a dangerous illusion. Investing is not easy - if it were, everyone would be a millionaire. If you believe that all you have to do to make money is hitch your wagon to a well-known investor, then you are unlikely to ever develop the skills required to stand on your own two feet in this arena. Why learn how to read a 10-K when you can just hit the "follow" button?

The second problem I see is that such systems do not account for the amount of risk taken on by "influencer" traders and investors. Most of these platforms have only been around for a few years at most, and the last month is the only time that users will have faced any real adversity. Before the coronavirus crisis, the U.S. stock market had experienced the longest bull run in its history. In such an environment, one could easily build a following by simply leveraging themselves and buying ETFs and popular stocks increasingly high valuations.

Any seasoned investor can probably see why such a strategy is flawed. Excessive leverage will magnify losses as well as gains, and there is no consideration of good value. But for a pretty long time, it would have outperformed a sensible value strategy, and no doubt would have attracted many new investors.

Of course, social trading platforms didn’t create these problems. They have always existed, ever since big investors began disclosing their holdings and retail investors decided to mimic them blindly. But the rise of electronic brokerage platforms, zero-commission trading and the ubiquity of mobile devices has compounded these problems. I have written before about the ways in which these innovations have been detrimental to investors. They have supercharged poor behaviour and have made it easier to make bad decisions faster. This is just one more example of this phenomenon.

Disclosure: The author owns no stocks mentioned.

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