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The rise of social trading: How the internet is changing investing

On days when cryptocurrency prices are down, Jordan Brookes Baker likes to buy the dip.

"Personally I enjoy red days like this, as they allow me to add to my $ETH and $ADA portfolios," writes Baker on her eToro profile page.

The 33-year-old is one of the "popular investors" on the brokerage platform's program — a trader with a successful track record that other users can copy.

"When prices fluctuate, to hold and to not panic and to not sell at a loss, which in my opinion is really the only way you lose money here is to panic and sell at a loss. So I just try to help my copiers keep that big picture perspective with me," Jordan told Yahoo Finance in a phone interview.

Baker's background in psychology and crisis management helps calm her copiers' fears. "I am doomed," writes user @Iamtiazfaheem, with a sad emoji next to his comment.

Time spent in front of a computer, large amounts of liquidity in the markets, and zero-commission trading has contributed to a new and young population of retail investors, a number of whom began trading in the public markets in 2020.

Social trading apps are competing for the influx of retail traders by combining social tools with the ability to trade.

A Fidelity survey earlier this year found of all the generations, 42% of Gen Z respondents were "most likely to say that they turn to social media influencers to educate themselves on investing."

'You can actually see what they're trading'

The GameStop (GME) phenomenon earlier this year highlighted what can happen when you combine social media and investments. Retail traders on Reddit's WallStreetBets spurred a massive short squeeze on shares of the heavily shorted video game retailer. A "working class vs hedge funds" narrative ensued.

The popular zero-commission brokerage platform Robinhood (HOOD), which was caught in the middle of the GameStop saga, advocates "democratizing finance for all."

Social trading platforms competing with bigger brokerage firms like Robinhood are each integrating social media in a slightly different way, but they all root for a similar mission.

"We want to democratize access to data. We want to democratize access to tools that hedge funds are using. We want to make sure that it's a level playing field," Guy Hirsch, U.S. managing director for eToro, told Yahoo Finance.

"People are sharing their ideas, sharing their thoughts about what to buy, what to sell," he said. "You can actually see what they're trading. You can see their portfolio, you can see their track record, you can see if they actually went ahead and took action on the idea that they're posting," he added.

'We're becoming much, much smarter'

The transparency in social trading is extending beyond friends and influencers. Some retail investors are following the stocks which politicians, or their spouses trade.

"Retail investing, we're called dumb money, but we're becoming much, much smarter with how we go about investing," Iris co-founder Christopher Josephs told Yahoo Finance Live recently.

Iris is a non broker-dealer social investing app, which allows users to see the same stocks friends, influencers and professionals are buying.

Iris screenshot
Iris screenshot

'It's a fine line'

The Securities and Exchange Commission (SEC) is expected to soon release a report looking into January's retail investor fueled massive short squeeze on GameStop and the chaos that followed. The "gamification" of trading is one of the topics likely to be addressed.

Earlier this year, Robinhood eliminated a confetti animation from its app used for first trades after receiving criticism that it was "gamifying" investing.

“Its a fine line. There's a lot of grey area here, which will make rule-making difficult,” Amy Lynch, president of FrontLine Compliance and former regulator at the SEC and Financial Industry Regulatory Authority (FINRA), told Yahoo Finance.

She believes any future regulation surrounding social trading will center around the question: "At what point do these digitalization engagement practices (DEP), at what point does DEP lead to a recommendation of a trade?"

Lynch says regulations would likely come in the form of disclosures, even more than the lengthy amounts that already exist on brokerage platforms.

As for users copying or influencing each other's trades, Lynch says, "As long as those traders are average Joe retail investors, and not employees of the broker, and not market participants in any way, then what is said on those platforms is just between those users and not under the purview of regulatory oversight."

'People can be anonymous within the community, but they can't be anonymous to us'

Verification is the cornerstone of brokerage platforms, which are regulated financial services entities. Bank accounts, phone numbers and full identifies are linked to member accounts.

"Each person gets one potential account, and those people can be anonymous within the community, but they can't be anonymous to us," COO Stephen Sikes told Yahoo Finance.

Members on the commission-free social trading platform can view stock, crypto and ETF trades others are making. The startup crossed the million member mark 18 months after launching.

"The most recent market events very clearly have increased interest in investing and brought an entirely new populations to the markets," said Sikes.

In February, Public abandoned payment for order flow, a practice seen by some as controversial. Instead it instituted an optional tipping feature.

"We are incredibly encouraged and really delighted by the quality of the discourse, and how constructive the community that we've built is in terms of talking about what to invest in, how to invest, what are good, responsible long-term investing principles," said Sikes. "We've worked really hard to be intentional in building that community."

'Just doing what I would be doing for myself'

New asset classes like non-fungible tokens may be influenced by social trading even more than stocks or cryptocurrencies, according to Hirsch at eToro.

"People are trading NFTs primarily based on signals they get from Twitter (TWTR)," says Hirsch. "In NFTs, social trading will be even more pronounced than what we see in equities and what we see in crypto."

Most of Baker's portfolio on eToro holds Ethereum (ETH-USD) and a small amount of Cardano (ADA-USD).

Baker says she feels the responsibility of other traders copying her position, but isn't "weighted down or burdened" by it.

"I take it seriously, but I'm just doing what I would be doing for myself. That's the integrity that you hope for in a copy trader, right? You're copying what they're doing, because what they're doing is in their best interest," she says.

"I feel pretty confident in how I'm moving forward with my money in this arena. I'm grateful that others are confident in me too."

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