Social Media and the Stock Market

by powste16

“Markets can remain irrational longer than you can remain solvent.”

– When Genius Failed (2000) by Roger Lowenstein

This was one of two lessons that I took away from my time on the trading floor (the other one being that every client will lie to you at least once). Both of these – irrationality and lying – remain true in the face of technological innovation, largely because they are innate human traits.

So what has changed? Much that has been written about technology and the stock market focuses on institutional investors and their technological advantages such as lightning-speed algorithms and dark pools. While some of this technology has trickled down, perhaps the greatest innovation from the perspective of retail investors is the rise of forums devoted to the stock market.

As both Rheingold and Christakis and Fowler point out, the Internet enhances – rather than detracts from – our social ties. By applying Christakis and Fowler’s framework, we can see that this is particularly true of retail investors:

  • Enormity: forums bring together retail investors who in the physical world do not have anywhere natural to gather since all the trading is done online.
  • Communality: not only can these (sometimes vigorous) discussions enable retail investors to become better informed but they also provide a platform for insightful retail investors to broadcast their views (which is how hedge fund manager Michael Burry got his start).
  • Specificity: these groups can facilitate discussion on a single stock or a single issue.
  • Virtuality: participants in these forums often have to create a short profile but can remain anonymous.

These forums depend on the two social norms highlighted by Rheingold – reciprocity, and to a lesser extent, trust. For the most part, forum participants are retail investors who trade for their own profit and often post their views to spur a “tit-for-tat” exchange – that is, to generate discussion and elicit views from others (there are some who post out of the goodness of their heart, but I suspect they are in the minority).

Rheingold focuses on the importance of “being a bridge”. The stock market trades on information and a “network-centered” approach is essential to gathering different opinions. In the traditional model, an institutional investor maintains relationships with investment banks that publish research pieces. Although research analysts arguably have an information advantage – they often have access to company management while retail investors must rely on published publically available information – using this channel alone lends itself to a filter bubble.

The market thrives on a difference of opinion (after all, you need a buyer and a seller to execute a transaction!). To overcome the filter bubble and to make informed decisions, institutional investors are increasingly turning to the plethora of information on the Internet in an effort to bridge the gap. The impact of social media on the stock market has been acknowledged by the likes of Bridgewater, one of the world’s largest hedge fund managers. Sophisticated investors have created algorithms that scrape social media sites to take a “real time pulse” of key trends. For example, instead of waiting for monthly car sales data to be published by National Automobile Dealers Association, investors can tally up the number of people who post about buying a new car online, and compare the aggregate statistics on a day-to-day basis

Some institutional investors look down upon their retail counterparts (sometimes called “dumb money”) and there have several academic research papers published on the underperformance of individual investors. However, technology has enabled retail investors to find a common gathering place and to benefit from collective intelligence. The question going forward is whether online forums will just be another way for Wall Street to exploit Main Street, or whether the forums will give retail investors a voice that institutional investors can no longer afford to ignore.