Can you beat the market reading stock market bulletin boards?
If you are anything like me, when you started investing in the stock market you read furiously to generate ideas. I subscribed to every newsletter I could get hold of. I hunted high and low for stocks that had the capacity to change the world. I searched the web for proof that other investors were buying them. This led me to the big bulletin board websites.
As a UK investor, I found advfn, iii and lse where there seemed to be thousands of investors bantering on almost every stock imaginable. I lurked for months, intimidated by the apparent expert knowledge of all the loudest voices before gradually contributing myself. It was the most expensive mistake I’d ever make.
I’ll explain why it was so expensive for me in a short while, but it wasn’t just me. Reading bulletin boards may be the most expensive mistake that anyone makes.
Since my own calamities in 2008, I’ve taken a huge interest into how and why bulletin boards are able to so deceive us into losing money. A few years ago I decided to start tracking the performance of the 100 most discussed stocks on the most popular online bulletin boards. I first revealed this chart at the UK Investor Show and haven’t updated it since, but even so, the results are damning.
It’s a picture of heart-wrenching ups and downs and consistent underperformance. For every story of someone who paid off his mortgage and sent his kids to private schools by ten-bagging on Rockhopper, there are hundreds of others whose crowd following have led to serious capital losses.
The typical punter investing in a collection of the most discussed stocks online would have been zeroing in on failure. A 10% average failure per year. So much for the wisdom of crowds !
Why do we get pulled into mob thinking?
It was the bull period between 2003 and 2009 that I used bulletin boards the most. I had some savings from my time as a wealth manager and had bolstered my funds with an inheritance after my mother passed away. Being Scottish, I had very good discipline ‘on the buy’. I never liked to overpay. At the time I used a strict rules-based purchase criteria that was very Jim Slater inspired, and for much of the period my exit rules were solid.
But Bull Markets create their own logic. Having initially purchased a sizeable position in a biometrics and RFID stock called RCG quite soon after its IPO in 2004, I gradually pyramided up my position as it kept breaking out to new highs. I grew increasingly confident till at one stage it was as much as 50% of my portfolio.
Now this was a profitable, growth stock. It actually had earnings, sales growth and a viable product. As I ventured online, I became part of a community of investors that were quite vocal about the company’s prospects. The summary of the story was…
“RFID chips are going to replace bar codes. Biometrics are going to be on every device in the world. This company is growing profits at 75% annualised and can keep growing at this rate for a decade. It’s only on a P/E of 8 and a PEG of 0.1. The brokers aren’t onto the story yet. Buy, buy, buy.”
Our community of investors online ventured offline too. About 30 of us met the management at the Mandarin Oriental Hotel in London. Everyone I met appeared extremely intelligent. Business analysts, successful business people, accountants, full-time investors. We were making big profits, I’d almost quadrupled my stake…
But what happened next was the worst of groupthink…
Why are bulletin board crowds dumb ?
One of the best books on mobs is titled “The Wisdom of Crowds” by James Surowiecki and it holds some great lessons for online investors.
Surowiecki talks about the four conditions that need to be in place to form a wise crowd:
- Independence - where people’s opinions aren’t impacted by the opinions of those around them.
- Diversity of Opinion - where every individual in the crowd makes decisions based on their own private knowledge.
- Decentralisation - where every individual is located separately and able to draw on different local information.
- Aggregation of Results - where there’s some mechanism to bring individual perspectives to a collective decision (e.g. a market).
The problem with bulletin board crowds is they break the first three of these rules.
Firstly, the initial frames for a stock pitch are often made by just a few very vocal, highly intelligent and confident people. People often defer to authority figures (known as authority bias) and so these ideas are shared and accepted by a growing number of people without critical thinking. This creates an information cascade that denies independence of thought, especially amongst time poor private investors. It also leads to over-confidence.
Secondly, diversity of opinion on bulletin boards is not welcome. Time and again when a critical, bearish thinker appears on a bulletin board he’s blasted as a ‘deramper’ or a ‘troll’. Often he’s banned from the thread. Investors only seek confirmation and confidence that their decision to stay long is correct, they seek to silence challenging or contrary opinion.
Thirdly, while most investors may sit in their home offices or at work, they often aggregate in a single forum to think and share all information together. This is the antithesis of decentralisation.
All these factors are completely contrary to wise crowd formation - and they tend to lead to groupthink.
In the cacophony of voices in a bulletin board the best storyteller with the best story wins. Funnily enough, the stocks most discussed rarely display the classic profile of winning stocks before their runs - in fact, on deeper analysis - they normally display the profile of losers !
As an illustration of this fact, I’m sharing a bubble chart of the 100 most discussed shares online (from the 2015 set) using the Stockopedia Value Rank and Quality Rank. These bubble charts show Value on the horizontal axis (from expensive to cheap), and Quality on the vertical axis (from junk to good). Good, cheap shares (which historically have outperformed the market) are in the top right corner, while expensive junk shares (which historically underperform the market) are in the bottom left corner.
As we can see, only four of the 100 shares in the list can be classified as “good, cheap” shares. The majority are worse than average and heavily leaning towards “expensive, junk”. The only reason to buy expensive, non profitable shares is because they hold the promise of exceptional future returns… a future that can only be sold in a great story by an authoritative storyteller.
How to use bulletin boards successfully
RC Group - the biometric share previously mentioned - was found out as a fraud. But the fraud took quite some time to unravel. The psychology of those who were long the share while the fraud unraveled was very telling.
It became a typical DABDA grief sequence… first the stock plummeted and most were in denial, then came anger but most stayed long. Then came the bargaining phases which is when I managed to sell out - a 50% loss from the peak, but thankfully still a profit on my original investment. But I know plenty of others who held on only to see a share that was once at a high of 144p fall to under a penny.
Since that rather painful experience, I’ve learnt that the simplest secret to making money reading bulletin boards is simply don’t ! As many Stockopedia subscribers may know, the site’s investment philosophy is to align with the historic payoffs available in the market and try to act contrary to the emotional crowd. It’s a philosophy that has worked and ought to continue working until the market is a lot more efficient than it is today. To do this one doesn’t need to read bulletin boards… one needs to understand what works in investing, and read, analyse & use company data.
To understand the amount of performance that bulletin board investors are missing out on, it is useful to look at the differential between their performance and a statistical benchmark. If you compare the performance of the 100 most discussed bulletin board stocks, to the top 10% of shares ranked by their Stockopedia StockRank (which is a simple model based on quality, value and momentum factors) we see a huge 96% differential over a 2 year period (see the chart below). As James Montier, the famed analyst and fund manager, has said “the evidence suggests that quant models tend to act as a ceiling rather than a floor for our behaviour… there is plenty of evidence to suggest that we tend to overweight our own opinions and experiences against statistical evidence.” The chart below is a few months old, but again serves to illustrate the point.
Frankly, the above analysis ought to put everyone off reading bulletin boards, but that would be short sighted. We’re social animals, we seek and crave validation, and the internet is an awesome vehicle to discover new information, more quickly than we could otherwise.
The key to using discussion boards successfully is to avoid using them as a primary source of ideas but use them for testing ideas, to keep Surowiecki’s comments in mind and to structure your thinking to counter our inherent behavioural biases.
Here are a few pointers to prepare one’s mindset whenever reading a bulletin board:
- Frame your reading with a sound understanding of what statistically works - when one understands the typical attributes of winning shares it’s much easier to spot a blatant, low probability story or ‘sucker’ stock.
- Avoid confirmation bias. If you find yourself reading bulletin boards just to back up your own opinion… don’t.
- Seek out contrary opinion - especially if it comes from intelligent “trolls”. Experience generally shows that they are more right than wrong.
- Beware of intelligent consensus - consider the opposite side of an argument if one side is in the ascendancy.
- Beware of Authority Bias - be skeptical of trusting the authority of any self-proclaimed ‘guru’, especially if hides his real world identity behind a pseudonym.
- Read Blogs rather than Forums - blogs are often written by independent thinkers who come to decisions from their own research rather than groupthink.
- Don’t buy stocks just because people are talking about them. Buy stocks when people aren’t talking about them. Sell them when they are.
And just to sign off, here’s a great parable that rather sums this all up…
A group of medieval scholars were debating how many teeth were in a horse's mouth. To answer the question, each person stood up and cited their favourite authority--but there was still NO agreement. A junior member of the group, then suggested that the group should go outside and simply "COUNT" a horse's teeth--to resolve the question once and for all! Upon hearing this, the rest of the group became so alarmed that, according to the manuscript, they "fell upon him, smote him hip and thigh, and cast him from the company of educated men."
Safe investing !
About Edward Croft
Co-founder and CEO here at Stockopedia.com. I was a wealth manager, then full-time private investor before setting up Stockopedia. I believe passionately in the power of data-driven investing to improve investment results. Oddly obsessed with the StockRanks.
Disclaimer - This is not financial advice. Our content is intended to be used and must be used for information and education purposes only. Please read our disclaimer and terms and conditions to understand our obligations.
Here is how you can profit from BBs. I will use advfn as an example.
- there are, believe or not, a few good posters who genuinely add value and deep knowledge. Yes, it is rare.
- make a note of these posters and follow their posts.
- on advfn, you can do this by simply doing a search on posters. This brings up all current and past posts by this poster
- browse the companies he comments on
- do your own research on those that attract you
From memory, I found two companies in the past year in this manner that turned a good profit.
I would emphasise that this method is just another way of identifying potential companies, and the heavy lifting of doing your own research remains your responsibility.
I'm not trying to promote the Motley Fool, but, as an owner of Arm shares, I think there are some excellent posts about the recent takeover offer on Motley Fool's Arm bulletin board:
http://boards.fool.co.uk/arm-holdings-plc-arm-50124.aspx
There are also, of course, many excellent posts on Stockopedia's bulletin boards.
So it is not true that all posters on all bulletin boards are idiots. But one has to be discerning in one's choice of bulletin boards!
I don't get the plaudits for this article. Yes, 95% of posters on bulletin boards are clueless. However, used intelligently, bulletin boards can be an extremely valuable source of information and ideas for investors. Used stupidly, by contrast, they will cause you to lose money. I find it hard to think of a stupider way of using bulletin boards than investing in the most discussed shares. All the author has done is taken an obviously foolish approach to investing and showed that it lost money. Big deal. Further, he seems to entirely miss the point that (as Paul Scott indicates) the methodology he has applied could potentially form the basis of a powerful shorting strategy.
LOL. The downvoters might want to think a bit more about this part of the article:
"Firstly, the initial frames for a stock pitch are often made by just a few very vocal, highly intelligent and confident people. People often defer to authority figures (known as authority bias) and so these ideas are shared and accepted by a growing number of people without critical thinking. This creates an information cascade that denies independence of thought, especially amongst time poor private investors. It also leads to over-confidence.
Secondly, diversity of opinion on bulletin boards is not welcome. Time and again when a critical, bearish thinker appears on a bulletin board he’s blasted as a ‘deramper’ or a ‘troll’. Often he’s banned from the thread. Investors only seek confirmation and confidence that their decision to stay long is correct, they seek to silence challenging or contrary opinion.
Thirdly, while most investors may sit in their home offices or at work, they often aggregate in a single forum to think and share all information together. This is the antithesis of decentralisation.
All these factors are completely contrary to wise crowd formation - and they tend to lead to groupthink".
Uncharacteristically, Ed has produced an article that, although interesting, is rather incomplete. The focus he chose is on the most discussed stocks on one site's bulletin boards. That's not what he asked though. He moved seamlessly to the specific from the general.
The answer to his question is without a shadow of a doubt yes, as two colleagues have proved over 15 & 12 years respectively.
I also, like Ramridge, read the better posters output. I would not be surprised to find that many discerning investors do likewise.
Of course, Ed's not going to produce an article that suggests using Stockopedia rankings and/or stock reports is inferior to another method! I'm not actually disagreeing with the thrust of his article by the way, I just felt that he was selecting an obviously flawed strategy to examine.
Scm.
Scm.
Cheers, rhomboid1. Are you my fellow PEG investor on ADVFN, or is that a different unequal parallelogram?
Yes -interesting article, and undoubtedly there is plenty of evidence of groupthink on active bulletin boards.
I've contributed to bulletin boards now for some 17 years, mostly on a handful of stocks, and have from time to time been thought of as a "guru" of sorts on one or two of them.....not that I've ever styled myself that way - the debates about the merits of a stock were always a matter of the quality of the arguments for and against for me, rather than a question of who was making those arguments.
I would observe that the quality of discussions has deteriorated markedly over the last ten years, especially since financial crisis of 2008. The most active contributors nowadays seem to be strongly motivated to drive the share price up or down on a short term basis, rather than making assessments that deal with the stock's merits over normal investment timeframes. The result is, in essence, lots of hot air and smoke - but not much light!
Disappointingly, also, there seems to be a sub-culture of negativism and a willingness to denigrate other posters with the aim of discrediting them and dissuading them from posting. This can apply to either bulls or bears. Its a sort of Gresham's Law for bulletin boards - the bad drives out the good.
I'd also observe that two sectors have, from time to time, dominated discussion boards - namely oil and gas stocks (other than the majors) ....and what I might loosely call "tech" - which basically encompasses all stocks that might be considered to have high growth potential based on some novel aspect of their business. Widget-makers and other companies that make their money from day to day trading activities are far less interesting to speculate about than those which appear to have transformative growth potential.......
.....and these same two sectors have had specific issues which can lead to the sort of investment disaster referred to in the article:
In the case of "tech" there is the issue of fraud (as you mention) as well as the technical failure of the proposition - or the failure to commercialise it properly. Such failures (other than frauds) often have at their root the fact that such companies are led by techies who love tech - and not by hard-nosed accountants or business people. Such tech companies also attract techie groupies on bulletin boards - and it can be tough to cut through to establish whether there is a viable business there or another Betamax opportunity to lose cash.
In the case of the oil and gas sector.....which has been widely discussed and speculated over throughout my time on bulletin boards.....it is impossible to escape the fact that commodity prices are a massive driver of investment returns. Broadly, 1999-2008 was highly positive for commodity prices and returns, and 2008-2016 has been neutral to negative (especially the last two years). I would argue that virtually all oil and gas stocks have been bad to disastrous investments for the last two years - quite independently of the amount of discussion on bulletin boards!.
I'd be interested to see what conclusions would be drawn from the same set of data if the results of the oil and gas sector were excluded (for reasons of the commodity price influence which dominated stock-specific factors in the returns). I doubt it would be as clear-cut.
.
Yes it's true that the majority of 'most discussed' stocks are Energy / Mining shares. About 65% are in the latest batch. But even stripping them out you find the same general theme.
I'd be interested to see what conclusions would be drawn from the same set of data if the results of the oil and gas sector were excluded. I doubt it would be as clear-cut.
It's late on Sunday, so I'm not doing a full analysis... but using my April 2015 collection if you remove the Energy and Basic Materials sectors from the set and analyse the last 12 months here's what you get:
That's an 11% worse performance than the FTSE All Share which is flat in the same timeframe. You'd probably find that the Energy & Basic Materials stocks did better than that.
The list that makes this charts is full of household name stocks (like the major banks, supermarkets, airlines) and speculative biotech and tech names. Frankly, that sums it up... people love to chat about things others know about too (availability bias) or lottery tickets. Both are expensive traits.
Hi emptyend
I agree with much of what you say. However, with regards to O&G stocks (and for that matter resources in general and gold in particular), there has been quite a marked turn around since the lows in early February 2016. Albeit from a very low base level, there have been some real gems in these sectors. I alluded earlier in this thread to an alternative non-Naps portfolio I have been running since the start of the year which includes several natural resources stocks which is now up over 60% YTD including Pantheon Resources (LON:PANR) Ithaca Energy Inc (LON:IAE) and more recently Sound Energy (LON:SOU) (as well as miners Lonmin (LON:LMI) and Glencore (LON:GLEN) ). I suspect several, if not all of these have been pretty active on the BBs (although this is not the reason that I am invested in them).
Best,
Gus.
Hi Gus,
Yes they generally are well off the lows - but if you look at the boards you will find sibstantial negative sentiment and total disengagement with the great majority of contributions being from people who were long from much higher up - and bitter about it.
Accordingly I think the volume of posts to currently be a very poor guide to stock-specific sentiment.
My clear and strong view is that most investors continue to avoid the sector, even as industry players are taking greater interest and M&A dicussions seem on the increase.
rgds
....ps.....I see that Sound Energy (LON:SOU) has nearly quadrupled in the last six weeks after flat-lining for months. I dare say there will be others that have decent prospects but have lain unloved in a sector few with fresh money are following
Thanks Ed.
.....but your closing point just reflects reality - you can't have a discussion unless there are sufficient willing participants, and that generates the bias towards high volatility stocks or the FTSE100 stocks that many people have in their portfolios. The interesting bit from an investment perspective is often the Bit in the middle.....
rgds
Good article - I've reached much the same conclusion from my own experience, which is why I rarely bother posting these days. Some examples of investor herding that spring to mind are:
(1) the High Yield Portfolio board on TMF
(2) the army of commodity bulls a few years ago here on Stockopedia.
(3) the Economy board on TMF for poeple who think we're going to hell in hand basket
(4) Bert's refuge on TMF for people who think everything's great
I think the thumbs down feature on Stockopedia is a bad idea because it facilitates exactly the behaviour you describe. Many posters will give a post the thumbs down when it doesn't act as a confirmation of the conclusion they want to hear. Often they will be unable to articulate any logical counter argument, but will give you the raspberry anyway.
Bulletin boards can be a useful source of information about a particular stock - along the lines of Paul Scott's excellent posts. But the challenge is to read posts without getting sucked in. If poster after poster is singing the praises of a stock, its only human to start viewing it in a more favourable light.
Very good article. But it basically states what I've realised for many years now. The worst example of this herd-like behavior are found with many AIM penny stocks. You'll see the BBs populated by a few 'know-it-alls' dominating, making ridiculous positive claims for such stocks, and the other contributing PIs regarding their pearls of wisdom as gospel. If any BB member challenges their views they are quickly turned on with no shortage of abuse.. When these stocks bomb as most inevitably do the know-it-alls make a quick disappearance from such BBs never to be heard from again.
I couldn't agree more. I used to be one of those know-it-alls on a few stocks on advfn back in 2004-2008. It turned out pretty badly for me too at the time. It led to a complete re-assessment of everything I thought I knew about investing, and ultimately led to the development of the tools at Stockopedia. We're only a fraction of the way there though.
This experience really drives my approach to markets and investing now... I'm fascinated by behavioural investing and how to put processes in place to avoid being afflicted by over-confidence, over-optimism, authority bias, herding etc etc.
Nice article,Ed.Re these frauds,you tend to find that they are always a bit cheaper than one would expect if they were genuine,except for the occasional price spike.I'm guessing that this is because insiders sell into strength.
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Ed,
Great article and builds on the comments you made at the UK Investor Show (I still think it was brave of you to show the bubble chart with all the the companies participating plotted!).
When I started investing, I looked on bulletin boards for information sources as did many others and was quickly put off by the general unpleasantness as dissenting views were shouted down and I developed doubts as to the qualifications of those who expressed strong certain opinions. There is a great quote I came across today:
"The whole problem with the world is that fools and fanatics are always so certain of themselves, and wiser people so full of doubts." Bertrand Russell
Perhaps this explains both the allure and folly of bulletin boards in one!
By contrast, I enjoy the blogs and columns on Stockopedia because a variety of views are exchanged, dissenting opinions expressed and debated, and uncertainty acknowledged. As a result I have learnt a huge amount. Keep up the good work!