The democratization of portfolio management and investment advice through trading signals

Technology has proven its ability to revolutionize the financial markets industry by serving as an infrastructure where physical and digital assets or financial instruments can be exchanged safely, cost-effectively, and reliably. The next step for technology to enter the full range of financial services is to create the surrounding infrastructure with the tools to provide services that will not only give access to markets and financial instruments but will lead to decisions about how to exploit them, aiming to the democratization of portfolio management and investment advice. Trading signals and copy trading are among the tools for achieving this target.

Trading signals, and copy trading, could be said that in essence, they represent, for the trading signals, a kind of investment advice, while copy trading is about a kind of portfolio management of financial instruments. What is remarkable, is that they do so in a very distinct way, as both serve a mission with high ideals. It is the idea that while reducing the cost of trade mediation, they democratize the arena of portfolio management and investment advice.

For the signals and copy trading as it is about a new financial service, as always two crucial questions need to be answered.

• How can the financial industry evaluate this service?

• How this service can be combined with the regulatory framework?

When investors decide to follow signals and or copy trades with each other the first step is how to be able to evaluate them so, they go to the second step which is to find how the respective service match their profile and regulatory compliance.

Evaluating trading signals and copy trading

In copy trading, one trader's positions are copied from another trader's account. So, it can be said that copy trading is part of a broader concept of Social Trading where traders interact with each other on exclusive platforms, as they follow each other's methods and copy their transactions.

The more information we collect about a provider the better conclusions we can draw about quantifying and qualifying the provider. And therefore, the better we can evaluate the signals and trades available to clients who are traders. But what are the qualitative and quantitative characteristics on which traders should focus?

Below is a non-exhaustive list of these characteristics:

• Profitability

Profitable return is a crucial feature of evaluating a provider's signals and or copy-trading. Positive return is obviously preferable to negative return. The negative return indicates weakness in the quality of signals and copy trading. On the other hand, the very high returns although they may seem attractive, require special attention as may some of them are probably due to the luck or the high risk taken by the providers. To evaluate the returns, a reliable approach is to look at the weekly and monthly returns to determine if the performance is distributed smoothly over time or if it is due to a specific period of time.

Concluding remarks: Smooth distribution of profitable returns.

• Consistency

A steady increase in profits is preferable to high volatility in the performance of trading signals and copy trading. Consistency of steady increase of returns states that that provider can manage risk and avoid alternating periods of high profits and losses. A provider who can have several consecutive lucrative months of positive returns with small losses in between is an ideal candidate to follow for copy trading and signals. The appraisal period should be more than 12 months. The longer the period of appraisal the greater the chances that the provider's returns will not be due to chance but to his ability.

Concluding remarks: More than 12 months of consecutive lucrative positive returns with small negative returns in between.

• Number of Trades

An indication that requires special attention and analysis that shows us the quality characteristics of a provider is the number of trades it makes, or the number of signals provided to the traders.

High number of trades undertaken or given by the provider can be a good indication for the provider as it may indicate that the provider has the capacity and experience to be able to adapt to the conditions and thus change the trading positions and signals according to the respective conditions and therefore success does not depend on luck. But on the other hand, a small number of trades may not necessarily be a bad sign as it also depends on the trader's strategy. For example, most long-term traders tend to hold their positions for a longer period, and therefore a smaller number of trades may be justified by this.

In essence, it depends on the type of trading. There are at least four types of trading: scalping, day trading, swing trading, and position trading. The different trading styles depend on the time frame and the duration of the period for which the transaction is open. For example, in Scalping the trading is very short as it lasts seconds or minutes. In Daily Trading the maximum duration is 1 day. Swing trading can last from several days to sometimes a few weeks. Finally, in Position Trading the duration can be Long Term and can be maintained for weeks, months, or even years.

Concluding remarks: Judge the number of trades and signals in relation to the trading style followed by the provider.

• Number of Open Trades

The number of open trades is a significant indicator of judging the quality of a trading system. As a general rule, the more open positions there are, the more precarious a trading system is. This is because large number of open positions may indicate that the trader is not activating the stop- loss orders, so he maintains negative positions for a long time with probably large losses. Some traders choose to continue to lose from open positions, so as not to negatively affect their statistics. Open positions that have losses are good not to exist for weeks or even months as this is rather a bad sign.

On the other hand, a large number of open positions may be due to market conditions or the strategy that a trader has chosen to follow. In this case, it is good to focus on the consistency of the retention time of open positions. If the average retention period of open loss positions is consistent with the average retention period of open positions, then this indicates that a large number of open trades is due to the trader's strategy.

Concluding remarks: A large number of open trading positions is a negative indicator of the quality of the provider, however, consider whether it is consistent with the average of open positions.

• Maximum Drawdown

Drawdown is the difference between the account and the net balance and represents how much money a trade lost before starting to win again. That means, Drawdown is not a real loss, but the loss that is observed before the trader who provides a trading strategy starts making profits again while the trade remains open.

Drawdown is a critical indicator, as it measures the largest potential loss of capital of an account. Therefore, it should be checked how much capital of a trader's account may be negative due to Drawdown, over a period of time. This information is vital because the same Drawdown is likely to occur repeatedly when the same strategy is used.

The biggest issue, however, arises from the fact that a large Drawdown can trigger a margin call, which can require large amounts of capital to enable an investor to bear a series of losses. It is therefore extremely important in terms of risk management to be able to estimate the maximum Drawdown so as to avoid margin calls.

The smaller the potential Drawdown, the more attractive the strategy you will follow. Even if a strategy shows a lot of profitable trades and small Drawdowns if it could occasionally show large Drawdowns, then it is best to avoid it. Drawdown becomes even more important for short-term traders who need to close at the end of the day trading positions as well as for those traders who make frequent withdrawals from their accounts.

Concluding remarks: Although Drawdown does not represent a real loss, even if a strategy shows many lucrative trades and small Drawdowns, if it can occasionally show large Drawdowns, then it is best to avoid it so that there are no margin calls.

• Slippage

If the signals that are underlined by a provider are short-term, therefore the potential returns are relatively small then it is important to be chosen to apply the signals to financial products with minimum slippage because a large slippage can absorb a big part of profitability. Therefore, returns can become much lower than what is assumed following a signal of the provider.

Concluding remarks: If the signals are for the short term, financial products with large slippage should be avoided.

• Duration

A provider's signals and strategies must be time-tested. The more time-tested a copy trading strategies or signals of a provider are, the more reliable is this provider. There are many cases that with a small amount of capital, with taking some risks and enough luck, strategies and systems have achieved high returns for a few consecutive months. But as time goes on, it becomes difficult to maintain such kind of results.

Duration is what makes professionals stand out from ordinary players. A trader with a history of satisfactory results of at least one year provides more confidence than one with a short track record.

Concluding remarks: A small amount of money, with taking some risks and a lot of luck can create positive results but these should be tested over time.

• Average Trade Size

The average trade size reflects the distribution of a trader's managed capital. If a trader increases his exposure rate on a particular strategy versus other strategies by a significant amount compared to the balance of the account, he is likely to take extremely high risks in their trades. The ability to maintain the allocation of funds in different strategies without large deviations from the average is an indication of the flexibility of the provider. Such an approach shows that the overall performance of this provider does not depend on a particular strategy and, therefore, the risk is properly distributed. Average segregation of positions below 10% per strategy seems like a rational approach.

Concluding remarks: The allocation of funds in different strategies without large deviations from the average is an indication of the flexibility of the provider and a rational allocation of risk.

• Number of Followers

Generally, we would say that if a provider has a lot of followers this is a positive sign, however, a large number of followers are not a certification of the quality of a provider. It is possible for a provider to have a large number of followers because he has used unfair methods such as copying activity from other successful traders or because of luck that has favored it for some time. There is also the case that some traders follow a provider for a long time because they were trapped in his strategy having negative returns since the provider has failed to activate the stop loss properly.

Concluding remarks: A large number of followers is a positive sign; however, it is possible for a trader to have many followers because he has used unfair methods, or because he has trapped many of his followers.

• Assets Under Management

It is most important to focus on the amount of money that is under management. The amount of money invested in a trading system for copy trading is probably a better indicator of a provider than the number that follows it. The high amount of assets under management indicates that the copyists are entrusting their real money to this provider. Moreover, a significant decline in the money under management directly reflects the lack of trust as well as the bad performance of this provider.

Concluding remarks: The high amount of assets under management shows that the copyists trust their real money to this provider while a rapid decline directly reflects the lack of trust in him.

• The Attitude of a Provider

The attitude is of great importance. So, it's good to know how to get some key points of the providers' attitude.

• How a provider behaves during and after a bad transaction? If he sticks to his tried and tested system, then this is a very positive trait in terms of his attitude.

• What is the amount of leverage a provider uses in implemented strategies? If the leverage is unjustifiably high, then his attitude is precarious.

• Which products does the provider trade in his strategies and why? If he specializes in some products then the attitude should be, the strategies he implements go hand in hand with his knowledge of those products.

• Which market or products does a provider specialize in? Specialization in specific markets is a strong qualification for a provider but the attitude needs to be that followers will only need to trust it in trading strategies and trading signals that relate to those markets.

Concluding remarks: A Provider's attitude is distinguished by the way it deals with a bad trade, the size of the leverage and the way of managing specialization.

All the above is a non-exhaustive list of features of the providers, which is necessary to analyze, on the one hand, because the quality of each provider that provides signals and copy-trading needs to be determined, on the other hand, this analysis is needed so that the next step can be taken, which is to determine how to identify the characteristics of each provider with the needs and aspirations of investors and traders. This is how the tools of signals and copy trading become useful.

And in order to do this, the crucial role of the Assessment of suitability based on Regulatory Compliance will need to emerge.

The crucial role of assessment of suitability

In terms of regulatory compliance, the customer-provider relationship, although strong, appears to be substantially limited. This is because although a trader who tracks a provider's signals and copies their trades is influenced by that provider, providers know almost nothing about their followers. In fact, providers do not and cannot have access to the portfolios held by people who follow their signals or copy their trades. This gives providers the freedom not to tailor their strategies to their followers, so it allows them to remain unaffected by the portfolio composition of their followers.

Indeed, the providers not only do not know the composition of their followers' portfolios but also know neither the personal characteristics of their followers, nor their preferences, nor the degree of risk they intend to take, nor their financial situation. Their relationship is anonymous and impersonal. Providers act in their own name and on their own account and take into account only their own interests and preferences.

As there is no client-provider relationship, trading signals and copying trading are limited to the granting of a right of use. In essence, providers allow traders to receive information about the trades they perform and give them the opportunity to copy such trades, also allowing them to receive and use the signals they provide to them.

So, the relationship between the providers and the followers appears strong, since indeed, the providers can influence the decisions and the composition of the portfolios of the followers. However, as already mentioned, the relationship is distinct and very limited in terms of critical information concerning both personal data and mainly the profile of their followers.

On the other hand, the followers of the providers should not just find a way to evaluate the providers according to their characteristics as discussed above, but mainly to focus on who are the providers that match their profile. Here is the crucial role that investment firms should take on, where through the process of assessing the suitability of their clients, they will bridge the road between providers and clients.

The bridging of the roads between the providers and the customers is achieved by the investment firms because it is these firms that can get to know both parties. They are the ones who can evaluate the characteristics of the providers as discussed above while they know how to evaluate through the assessment and suitability the profile of their customers, and thus to look for the way the providers can match the customers.

Evaluating providers is a process that requires quite good knowledge of the composition and analysis of several characteristics of providers such as their knowledge, experience, behavior, and consistency. An even more complex process, however, is the synthesis and analysis of the customer profile through the assessment of the suitability process where, by assessing the financial situation, the experience and knowledge, investment goals, objectives, and risk tolerance of the customer, can be identified the needs, aspirations, and real aims of the customers.

The big challenge is to find out under what conditions one side, i.e., the customer's side, is suitable for the other side, i.e., the provider's side. And vice versa. This challenge is a big responsibility that investment companies are called upon to take on because they are the ones who need to have all the knowledge and information to assess the suitability of both parties, i.e., providers and clients, in order to match these two parties, in the best possible way.

The responsibility of investment firms is vital because ultimately, they are the ones who can really assess the suitability of all parties, analyze and synthesize both the client-side and the provider side, so that they can find a common ground where one side should act to the interest of the other side, serving common values ​​and purposes.

In this way, the democratization of the management and advice of the client portfolios can be achieved, as this is the big new request of the new era of consulting and portfolio management that has already come.