Social media sites like Facebook, LinkedIn, Twitter, have introduced a whole new age of transparency, revolutionizing the world of finance.

Are private investors the trading experts of the future? Until recently, trading was considered the exclusive domain of experts working for banks and investment funds.  After all, they have access to reams of information in real time, and they are often part of a global team of experts which provides a steady stream of comprehensive market analysis.

However, recent studies have shown that typically a mere third of all actively managed investment funds succeed in outperforming the benchmark.  In these turbulent trading times, it is becoming more and more difficult to make the right investment decisions.  With the growth of social networks supporting the free exchange of information and copying of expert traders , institutional investment experts now face increasing competition from private investors, who through sheer performance have turned into investment gurus.

Social Trading and Knowledge Sharing

Social trading is based on the principle that knowledge should be shared and made accessible to everyone, so that each member of the community can benefit from the collective expertise. Knowledge and experiences are shared openly and transparently, visible to all. Thus, there are no secrets or covert areas, no “black boxes” containing expertise for only the few.

Social investing platforms, now fairly common, enable traders to register, trade transparently with others, and benefit from other traders’ experiences. The exchange of information isn’t limited to forums and discussions: all traders publish their activities, making them completely visible for everyone else – in real time. The key parameters are also visible, including not only their average returns, but also the risk level traders are willing to take to achieve them.

The platform’s resulting rankings are different from those of the funds industry, since they report the performance of each private asset manager, and not of an entire team. Moreover, these asset managers achieve their results using their private money, which can boost their credibility for a potential follower or copier. By showing how many copiers each trader has – i.e. how many other users replicate his or her investment decisions – the system also documents the ability of successful traders to groom other potential expert investors.

When eToro started its social investing platform, there were many finance experts who were dubious about their transparency model. They believed investment experts would not be willing to share the secret of their success.  Surprisingly enough, many traders were happy to discuss their strategies and opinions, and openly admit they enjoy sharing their success.  In addition, most expert traders receive tremendous personal satisfaction from their ability to attract a loyal following.

Wisdom of the Crowds

But does the sharing and passing on of information really work? Is there an “invisible hand” in social investing? Here’s a real-life example showing it does. When the earthquake and the following tsunami hit Japan in the spring of 2011, the social net proved to be an uncanny seismograph. Immediately before the horrible news spread like wildfire around the globe via major agencies like Bloomberg and Reuters, the eToro network recorded drastically increased activity, e.g. in USD/Yen currency trading led by local Japanese traders.

Preliminary evaluations show that trading in social networks can significantly improve returns. Comparing traditional trading transactions and transactions via eToro’s unique CopyTrader™ funtoinality, eToro found out that “copied” trades deliver both better success rates and higher average returns per trade. Traders were able to improve their results by 10 to 100 percent, making the ratio of profits as compared to all trades increased by 8 to 12 percent.

eToro is currently verifying these observations by participating in a scientific study carried out at the Massachusetts Institute of Technology’s (MIT) Media Lab. The study, which is part of the NYU Stern School of Business’ “Workshop on Information in Networks” (WIN), examines the ways in which information in social networks influences social and economic processes. Using the field of computational social science as well as disciplines including computer science, economics, physics, and political science, the study analyses the dynamics of information dissemination in social networks. Social trading enables the viral distribution of potentially valuable information, working as a kind of filter allowing only valuable information to be spread. According to research carried out by Dr. Altschuler, the director of the MIT Media Lab study, the conditions that allow both roles to take place can be calculated mathematically. Providers of social trading platforms can use insights about patterns in trader behaviour and information dissemination to develop new tools and systems for their users. The first results of the study are expected to be available in approximately six months.

Conclusion

Social networks lead to the development of new markets in which collective knowledge and expertise is shared to benefit all members. These markets are open, transparent, highly efficient, and solvent. They meet investors’ desires to take more responsibility for their own investments and to participate actively in the markets. In addition to boosting individual returns this phenomenon can actually influence how financial markets behave.

About the Author

Johnathan Assia, Chief Executive Officer

• Co-founded eToro with his brother Ronen in 2007
• B.Sc. in Information Science and Computer Management, University of Tel Aviv, Israel, 2005
• M.Sc. in Computer Science, Herztelia Interdisciplinary Centre (IDC), Israel, 2007
• 8 years experience in software development and software management as well as 10 years experience in investment and currency trading
• Founded and ran his first company CD ride from 2000 to 2007

About eToro

• The largest global investment network with 1.75 million users in 140 countries and thousands of new accounts opened daily
• Aims to open the financial markets to everyone by providing an easy-to-use, transparent online trading platform for currencies, commodities, and indexes
• Investment network based on a broad range of innovative, web-based and mobile trading platforms covering the entire trader expertise