Market traders have always needed to be acutely aware of macroeconomic trends and company news. As a result, stock, commodity and currency trading has long been the preserve of dedicated professionals and those wealthy enough to pay them.

Social networks and online communities have gradually eroded this exclusivity, giving birth to social trading in which people share strategies. On Reddit, the stocks thread has 371,000 people discussing what they buy and sell.

David Myers, head of Deloitte UK’s capital markets practice, says social trading is part of a much wider trend towards increased transparency and open information. “Just as people are looking to invest in companies with more responsible, sustainable and diverse operations, access to open information has become a focal point,” he explains.

Social trading brings word-of-mouth credibility

While many investors still tend to favour safer options for investing money, according Mickael Tabart, partner at KPMG Luxembourg, social trading is making waves in fund management, particularly for younger users. He says: “The data captured by the technology used on the platforms has given rise to new, unbiased ways of reporting performance that make the link between costs and return much clearer for the investor.”

Given that the individuals in many online communities are not rated, dedicated platforms have been built to showcase traders’ performance and allow users to copy their actions. One platform, eToro, has grown to ten million users trading multiple asset classes.

A fundamental benefit of social trading is front of mind for consumers: “The people you are copying are investing their own money in the strategy,” explains Iqbal V. Gandham, UK managing director at eToro. “This is unlike traditional fund managers, many of whom may not be investing their cash in the funds they’re getting customers to invest in.”

In addition, the desire for recommendations in different aspects of our lives has been a powerful force, Mr Gandham says. “If you want to go to a good restaurant, you might ask a friend who knows the best ones. Or to do better in the gym, you’d try and find a well-rated personal trainer. We are so used to asking advice and seeking ratings, but it’s only since social trading that this has become available for investments,” he says.

A fast-growing aspect of eToro’s operations is mirror trading, whereby customers can automatically execute the same buy, hold and sell decisions of those they are following. “Previously, people looking to trade would have had to trawl through newspapers and tip sheets to study company performance, but now they can quickly copy experts,” says Mr Gandham.

What are the drawbacks of social trading?

Social trading, on eToro and other large platforms such as ZuluTrade and ayondo, offers previously unseen market accessibility, alongside the ability to earn money without significant time or capital outlays. There is also potential for those who become expert traders to generate revenue by being copied.

There are, however, clearly some substantial downsides that must be considered. A major problem, Mr Myers notes, is that people are sometimes investing their own money based on the decisions of someone who is not a qualified expert, a particular concern on social networks where there is no performance history. On the Reddit stocks thread, one user counsels: “Take what you read with a pinch of salt.”

People may also be tempted to bring in excessive leverage to boost their investments, particularly in foreign exchange. While loans can significantly increase any gains made, they also magnify losses. And no matter how smart the people being copied are, there is the potential for the investment value to nosedive. Some 67 per cent of people polled by the website Social Trading Guru said they have lost cash, with impatience and rapid use of leverage shouldering part of the blame.

As such, it is advisable for new traders to limit early investment, choose risk and leverage carefully and take up the opportunity to copy several traders so any losses may be balanced out. “Making sure users have the right financial education to make decisions is a priority,” notes Mr Tabart at KPMG. “Retail investors should at least be familiar with the ground rules, like diversification of portfolio, before starting to use the service.”

Providing valuable data for investment firms

With a healthy weighing up of the pros and cons, social trading clearly offers good potential for retail investors. They are not the only ones who stand to gain, however. Professionals are yielding insight into market mentality, shifts in momentum and signs of where activity might be heading as part of the total information that banks and funds routinely trawl through.

Deloitte expects this set of “alternative data” to be a $7-billion market by next year. “There is significant sophistication already, with investment firms tapping into masses of online comments on customer satisfaction around products and looking at satellite images of shopping malls to monitor their popularity,” Mr Myers explains. “Many use advanced analytics to identify new patterns.”

Among the companies making this possible is the French financial technology firm SESAMm, which analyses billions of alternative data points from more than two million online social messages, news items, articles, images and videos, distilling it rapidly into actionable insights for investors.

“Hedge funds, investment banks and asset managers use our machine-learning and natural-language processing to understand market sentiment,” says Sylvain Forté, chief executive of the company. “We analyse the data to present different use cases, which can be as simple as saying ‘buy and hold’, or it could relate to a stock picking strategy or forex hedging.” As recently as three to five years ago, Mr Forté adds, “none of what we do now was possible”.

Firms setting up their own social platforms

A number of large institutions are also keen to offer their own social trading platforms to win and retain new customers. TradeSocio is one firm at the cutting edge, supplying mobile and desktop social trading and robo-advisory platforms to banks, brokerage houses and fund managers, that in turn present them to customers ranging from individuals investing £10 right up to those with considerable wealth.

Wael Salem, chief executive of TradeSocio, explains that financial institutions see clear benefit in offering mobile access to trading strategies for myriad instruments, backed by openly measured risk management and deep investor communities.

“Fund managers need to reduce the cost of acquiring customers and of retaining them, and they are seeking to increase customers’ lifetime value,” he says. “Social platforms lead to much cheaper customer acquisition, and people are often persuaded to stay by having a mobile app, strong interaction with other users and the possibility to easily partake in professionals’ strategies.”

Using social trading in all its forms, consumers have their sights set on growing their wealth by copying the strategies of experts. The gains made by many will be significant, but so too will be the losses of others who fail to manage risk. As millions more social traders hit the markets, professional fund managers will pour money into better analysing the total data available, so they can be ahead of shifts in market sentiment.