By Yoni Assia, CEO of eToro
Picking one or several traders to follow can lower the learning curve and minimize the risk.  However until now each trader that is copied would need to be followed separately.  Now there is a new development that makes it even easier to build and maintain a diversified portfolio of traders that together comprise a social index.
The same way that the S&P500 includes the biggest 500 companies, now it is possible to  create an index of top traders. You can decide how to filter and profile the type of traders you want to include in your index, from the best Euro traders to low risk traders to the traders with most followers. However here is the a dilemma, now that you have all this flexibility to tailor your own social index how do you  know which traders  to include?
Well the first question you have to ask yourself is what kind of return you would like to have, stable and low over time, high as possible, or more balanced.  Of course you have to consider a simple equation, high returns = high risk and high volatility, low risk= low return but more stability.  Since balance more or less captures elements from both high risk and low risk, this could be good strategy to start with.
How to create a balanced index?
A balanced index has to basically contain good short term traders as well as long term traders. It is the precise combination of short term and long term investors that gives the balanced social index its profitability and stability.  Now the challenge  is to characterize what is   a good long term trader and a good daily trader (short term) and to decide what is the optimal mix.

What makes a good long term trader? A good long term trader is a trader which trades in low leverage, has double digit annual gains and  most importantly his profit chart is rising steadily rather than having extreme peaks and valleys creating a sense of a roller coaster ride.  The gains or yield curve is the most effective tool to identify the volatility of the trader’s returns and if he can be considered being the game for the long term.  
 
Once you have identified a long term trader you want to include in your portfolio you need to determine the optimal percentage of your total investment you should allocate to long term traders provide you with a stable flow of  returns.  The revenues from this investment is like an anchor to your overall investment strategy.

From our experience, the most profitable portfolios have one or several   long term traders that comprise  at least 80-85% of the total index It is important to maintain this ratio to have insurance against high and low swings that are common for short term trades.

In  contrast, the short term traders’ composite of the index should be rather small only 15-20% of the entire index.  Although the percentage may seem low,  it is crucial not to overlook them and to make sure they are included in the portfolio.   Despite the higher risk levels,   this is actually the portion of the index which can give you those extra returns that beat the benchmarks.

However, just as important as making sure day traders are included, it is essential to make sure you  pick the right ones, that trade consistently so the results are more predictable. A good daily trader usually trades with  a fixed level of risk and potential for all of his trades and knows how to replicate his success several times a day or at least once a day. Therefore when seeking a good short term trader  check  that he has good returns,  his trades have more or less the same distance of stop loss and the same distance of limits.

The final parameter after figuring out if your short term trader has a good risk strategy and has a good return is to examine his win ratio which basically tells you if your trader is right most of  the time.    A win ratio higher than 65% with good returns and stable risk reward strategy alongside short duration trades makes the perfect daily trader.

When building the portfolio it is important to remember the higher levels  of risk for a day trader.  The disadvantage is that a short term trader usually uses X100 leverage which means risk for each trade is higher than for say a long term trader.

Setting up a balanced social index however is only the beginning.  Performance for long term and day traders have their own peaks and valleys.   It is important to regularly monitor, measure and then evaluate each trader included in the social index.   The yield curves for individual trades should be analyzed, and in the event a trade falls outside of the guidelines it should not be copied.

Traders are only human and it is also possible that their trading strategies can change.   Any time traders change their risk levels, or trading patterns significantly it is important to readjust the index accordingly.   If there is any divergence it is essential to swap out the  traders and replace with more relevant ones that meet your criteria to keep the index performing according to your expectations.  It is important to make sure that the long term traders and day traders stay true to their character  and are in accordance with your initial criteria.

A balanced index requires constant growth and pruning to keep  on track.

Once you combined the two elements ,  85% of long term traders and 15% of day traders, and then successfully monitored and maintained this ratio,  you can experience the benefits of a more diversified portfolio.  If your index consistently brings the expected returns it can be made available for other traders to follow, providing an additional revenue stream and another opportunity to leverage expertise to enhance the trading experience.

Building a balanced social index benefits all the members of a social trading network.  The basic recipe for a balanced social index, achieves risk management through diversification to improve the chances for trading success.