How do Social Trading Sites Like Etoro Make Their Money?

in #socialtrading7 years ago

In the 'Good old days', if you wanted to trade stocks and shares, or any other form of asset, you'd have to find yourself a broker... Remember those pics of guys in the 80's with the big phones and the braces and the ferraris in cities - those were the guys. You'd have to find yourself one of them and then pay them commission to make trades for you. They'd recommend assets and you'd go in with as much as you could afford, or a little more if your broker was also a good salesman. That was just how it was. You paid them fees, and they traded with your money. Every trade, another fee to the broker.

Fast forward 30 years, and the internet's in full swing. Social networking sites are so common, everyone can use them, and does - they're now integrated into daily life for a large part of the world. Social trading sites are built on our familiarity with social networking. We know what a 'Profile' is, we know what a 'Like' is or how to 'share' something we've seen. All they've done is added this as a layer over a trading platform built with an extremely social-media friendly user interface. Then they introduced Copy Trading. This little miracle of the modern age lets you copy more experience investors automatically, for free. So who gets paid what? And what do I pay?

So, firstly, there's me - the guy who knows nothing about trading other than it looks like a great way to make money - if I only i knew how it all worked. I come in, and I can either take my chances trading myself (in which case i pay a little fee on every trade called a 'Spread Fee' which goes to the borker) or i start Copy Trading and browse through all of the 'Popular Investors' (I'm using Etoro as the exmaple here) who are the various traders I can copy, at which point my account will automatically copy all of the trades their account makes. At the same time, with whatever amount of money I've predetermined. And I can do that for free.

The popular Investor is the second type of guy - they're on the social trading site, trading their own money, paying the little spread fees (there's also overnight and weekend fees, but that's a separate article) and trying their best to make money. They've asked the social trading site if they can be a 'Popular Investor' - the site's applied their criteria for inclusion, said Yes, and now our second guy is not only trading his own money, but he's also got people automatically copying his trades. And they're not paying him ... The Social trading site is paying him - the more people copy his trades, the better the perks the popular investor can make - from rebates on spread fees, to a monthly payout, to 'education allowance', to 'monthly marketing budget', there's a wide variety of perks depending on how many people copy you. The best of which is 2% AUM - Assets Under Management. So, if a popular investor reaches the heights of copier-numbers, they can actually be paid 2% per year (paid monthly) of the overall amount that people who are copying with have invested in them. That can be a LOT of money.

So finally, we've got the exchange. They pay the popular investors, and they collect fees from absolutely everyone else (including a percentage of the lower level Popular Investors, who only get partial 'spread fee' rebates. The spread fee is a small percentage of the value of each trade which is taken right as the new trade is opened. They vary depending on the asset being trades, and the volatility of the asset in question (volatility just means how much the price is moving up and down quickly). These little spread fees all join together like little stream, eventually leading to a mighty Amazon-like river of money pouring into the exchange. If they make the spread fees too high, everyone will go and trade elsewhere, so there's a constant pressure to keep them as low as possible. They also charge overnight fees and weekend fees - tiny fractions of money each night a trade is held open until the next day - with a weekend fee being 3 X 'overnight fees' (Friday, Saturday, and Sunday)

So, the regular Joe like me pays spread fees and can copy people for free (yay!)

The popular investor pays spread fees, but they get lessened as they climb the ranks of popular investors, and they start to get money back from the social trading site as they gather enough copiers

The social trading site gets spread fees from everyone except higher-ranking popular investors, and pays out to the popular investors on a scale depending on how many copiers they have.

It works well as a system. Everyone feels they're getting something for free. And everyone, hopefully, is making money. Where's the money coming from? Whoever's on the losing side of the trade...

Etoro also charge a conversion fee as all money in their system is in dollars, so they exchange it unless you're actually crediting your account with dollars, and there's also (at the time of writing) a $25 withdrawal fee. I made a video about all the fees - I'll pos it separately, it's more useful than this...

The information and opinions in this post are not intended to be investment advice. Seek a duly licensed professional for investment advice.

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