To follow or not to follow – An empirical analysis of the returns of actors on social trading platforms

We analyze the returns of traders, i.e. signal providers, on social trading platforms and of investors following these traders by utilizing differently sophisticated investment strategies. It becomes evident that simply investing in those traders with the highest accumulated returns leads to high losses, while taking the Sharpe ratio into account improves the achieved returns. Positive returns, however, are only possible for sophisticated strategies that consider information on the risk of the signal providers’ portfolios. Moreover, no strategy reveals a positive abnormal return after transaction costs in the sense of a Carhart four-factor model. Further, we analyze predictors of the weekly returns of the signal providers in a panel set-up. We find that highly active trading behavior is negatively related with the returns, while there is no wisdom-of-the-crowd effect, in the sense of a positive relationship of the number of followers or invested capital with the returns.