Beware the risk of echo chambers on investment discussion boards
It’s hard to overstate just how important the internet has become to individual investors. Over the past two decades, online services have unleashed cheaper trading and better quality tools and information. But not all of these new services are problem-free. With a growing army of investors online, investment discussion boards have proliferated. While these boards can be a source of ideas, they can also be a hazard to both your wealth and your sanity.
We’ve warned before about the way emotions and behaviour cause chaos whenever you get groups of investors talking together (especially when they’re strangers). Last summer - in Can you beat the market reading stock market bulletin boards? (here) - Ed showed how discussion boards can be awash with ‘groupthink’. They become well-protected havens of one-sided information, often with a preference for small, highly speculative stocks that tend to perform badly.
As the excellent Tim Richards has written - in an article that covers the same research I’m about to - the killer cognitive error here is Confirmation bias. Our natural inclination to hear views and opinions that agree with our own give investment discussion boards magnetic appeal.
Until recently, data on the influence of these boards has been pretty limited. We’ve done our own assessments of how popular bulletin board stocks perform - and the answer is often quite badly.
But in reality, many investors don’t need data to know just how aggressive and misleading some bulletin boards can be. We regularly hear from individuals who say they’re rehabilitating from the costly mistake of using forums as a primary source of investment ideas.
Hunting for the facts about investment discussion boards
Earlier this year, a group of researchers in the United States picked up the challenge of quantifying these risks. Their starting point was 34 million message posts across nearly 13,000 boards covering quoted US companies. These came from the Yahoo Stock Message Boards and InvestorHub, which is owned by ADVFN. Between them, they claim tens of millions of visitors every month.
The point of the research was to find out whether investment message boards provide a useful service. Specifically, they were looking at whether user sentiment changed much depending on external information about stocks. In other words, if there was bad news about a company, did the message board reflect it?
They also wanted to know about the community structure, and the role that individuals play in shaping the the discussion. Finally - and crucially - they wanted to know whether discussion board sentiment was any good at predicting the performance of shares.
For some, the answers won’t be entirely surprising. For a start the data showed that the highest levels of discussion activity were around “small market cap stocks with higher risk and volatility”. It turned out the heaviest post traffic was found in highly speculative nano-caps, valued at less than US$50 million.
Second, the research concluded that message board sentiment was absolutely no guide to a stock’s performance. They found that “regardless of how a stock performed, sentiment in discussion boards is almost uniformly positive and upbeat”. This, they suggested, was simply down to poor user-generated information. They backed it up with simulations and found that trading based on discussion board sentiment significantly underperforms market indices.
Third, it turned out that while discussion board sentiment doesn’t predict the future performance of a stock, “board activity as measured by the number of message posts does correlate with future stock trading volume and volatility”. Which means that heavy discussion of a stock can drive up trading activity in it, but that doesn’t mean the price will rise.
How forums play to our vulnerabilities
Overall, the researchers concluded that investment discussion boards resemble echo chambers. By using ‘unsupervised learning techniques’ (a way of finding patterns in data using machine learning) they found the boards were insular and actively rejected viewpoints that were disliked. As a result, they were clearly poor sources of information for anyone looking for credible ideas.
But there was more. They found that the discussion threads on most boards appeared to be controlled by very small groups of users. Over time, any negative sentiment was drowned out as the threads were taken over my more and more “reacting users and followers” whose posts reinforced each other and the overall sense of positivity.
The net result of all this is that online investment discussion boards actually fail to achieve what they set out to do, which it to predict future stock returns. In fact, they encourage some of the best known behavioural weaknesses in investors.
For a start, they appeal to our love of a good story, by channeling interest towards higher volatility, lottery-like stocks. Message boards were also found to do a terrible job of properly incorporating new information. This is a classic symptom of Anchoring and Conservatism bias, where individuals tend to over-emphasise the importance of earlier information and are slow to react when the story changes.
Finding a better source of guidance
In summary, the researchers were damning in their assessment of the average active user on an investment discussion board. They described them as “irrational investors stubbornly positive about long shot bets.”
But despite these failings, it’s understandable why message boards have such magnetic appeal for many other investors. As the researchers note, it’s natural that investors look to others for guidance, it’s just that this online community of other investors is a poor group to model.
The ambitious solution to this seemingly intractable problem is for message boards to be more encouraging of divergent opinions and the open exchange of ideas. But while we wait for that to happen, it’s worth remembering a few suggestions when it comes to investment discussion boards:
Discussion boards can be a useful source of inspiration. But check your stock ideas against pre-prepared checklists or a framework like the StockRank Styles and RiskRatings so you can understand quickly what you’re dealing with.
Be aware of your cognitive and emotional weaknesses. Bulletin boards are the perfect place to indulge in Confirmation bias, so seek out contrary views too.
Small groups of active users on discussion boards can lead to the establishment of ‘authority figures’, and the associated risk of Authority bias. These individuals may well be anonymous and know nothing - so treat them with caution.
The research suggests that high post traffic discussions covering small companies can increase volatility in those stocks. So stay cool in the face of frantic share ‘ramping’.
For Ed’s analysis of how the most popular bulletin board stocks generally perform (published last summer), click here.
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.
19 comments
Good article. Confirmation bias & group-think are almost certainly strong factors we deal with when discussing the merits of individual investments.
In addition there is also a very powerful but more subtle effect at play here as well. It is not just being influenced by others' opinions that we have to worry about but being influenced by our own public statements. When we make public statements about our opinions we find it very hard to change our minds on a subject even when the facts change. We have a strong psychological desire to appear consistent. The problem with applying consistency in investing is that no company is a buy or sell at any price. The facts change over time as results, outlook and price action are constantly changing. We need to be able to change our mind as the facts change yet this will bring us into conflict with our desire to appear consistent to our previous public statements. This is very hard to overcome due to both its power & subtlety - we may be completely unaware of the effect.
I wrote a bit more about this here: http://www.dangercapital.co.uk... concluding
However next time you make a public statement about the investment merits of a particular share it’s worth thinking in advance of what events would cause you to change your mind and sell (or cover a short.) Even better write them down, so you have made a public commitment to yourself to change your mind if the facts change and you’ll at least want to appear consistent to yourself with that.
Better to use your own opinion as guidance then u only have yourself to blame. Most of the time you can just follow the general direction of the market with your trading but watching the relevant indices, eg FTSE100 https://www.stock-trkr.co.uk/live-charts/indices/ftse_100_live_chart
Yes I did Ken and it is the direction I am moving my portfolio towards. The Stockopedia tools are a great help too.
Hi Crazy
Did you see this http://www.stockopedia.com/content/high-returns-from-low-risk-van-vliet-a-book-review-and-recommendation-191909/ I thought it was great for long term investors.
Regards
Ken
Hi Ken
I spent 4 months last year running with c40% cash due to conerns over Brexit/Trump and it really hurt me in terms of lost dividends in Q4/Q1. Therefore, I have decided to mainly be fully invested - time in the market rather than timing the market! The launch of Stockopedia's risk ratings has been wonderful timing for me as it has helped me to balance my portfolio, moving more towards larger cap, divi shares with a conservative or balanced risk rating and reducing exposure to small cap, high momentum holdings that tend to have adventurous or speculative risk ratings. It's still a work in progress getting the balance right but nonetheless, I am convinced that it is preferable to being out of the market, holding large amounts of low/no return cash.
Cheers
Simon
Great article. Thank you.
I did subscribe to ADVFN for a couple of years but didn't follow the bulletin boards because I couldn't understand them, so I probably had a lucky escape.
As to the state of my investments, unlike most commenting here I am pretty much fully invested in what I believe are good companies, which I believe will still be good companies in five to ten years times, as I just don't feel I can predict the next pull back/correction/crash. And with research showing that the majority of gains are made on relatively few days I think it is important to be invested to catch those days.
Purpleski. I really can't disagree with a word you have written, quality shares will always come through in the end, but, always a but--- I am out and the pain of getting it wrong is stronger than any potential profit. But I can tell you when to sell, it will be when I persuade myself that I am premature and buy back in and that feeling is growing by the hour. It is at times like this when I really admire the long term investor buy hold ignore smile. I have just read Ed's blog on tortoise and hare low risk investing sounds like a cool drink to a man dying of thirst. Hold me back, tie me down, please let my broadband collapse, just a small investment can't hurt-- does anyone have the number of Investors ANONYMOUS!!!
The "majority of gains in few days" meme is a bit fallacious: it's true, but the majority of losses are also in a few days, so being out as such is rather neutral: you're as likely to miss big down days as big up days (and the former tend to be larger than the latter...). What one is really missing when out of the market is the average equity premium, not the outliers.
Correlation.. but not necessarily Causation
board activity as measured by the number of message posts does correlate with future stock trading volume and volatility”. Which means that heavy discussion of a stock can drive up trading activity in it, but that doesn’t mean the price will rise.
ok, it may correlate, but it does not mean it causes trading activity. It could be a more fundamental reason causes an increase in both message posts AND trading activity... eg looming results.
cig,
"Also how often in history has a crash been preceded by everyone saying "there's a crash coming". A bubble is when (almost) everyone is (frantically) optimistic."
Actually most of the time!
The conventional wisdom that markets crash from a point of maximum optimism, the stage where " cash is trash" is wrong, at least in my memory.
Think back to the dotcom bubble. The media was not full of bullish headlies proclaiming that it had to go on forever. In fact, the situation was usually being referred to as a "dotcom bubble" and there was a widespread expectation that the bubble would burst at some point. I can remember one TV documentary about entrepreneurs who were scrambling to bring their startup companies to market to cash in before the inevitable return to reality.
The same in 1987. The sudden crash may have come as a surprise, but there was a widespread belief that prices had run up too far in the aftermath of "Big Bang."
Even back to the South Seas bubble. The story of Sir Issac Newton losing a fortune at the end of that bubble is widely told in investment books, but the fact is that he did foresee a crash coming and wrote that markets were overvalued well in advance.He may have been suckered back in out of greed, but he was expecting a crash at some point. Presumably he thought that he would be able to avoid it.
Just for clarity, I certainly don't think we are in bubble territory at the moment. Just perhaps overvalued.
Hi Velo, yes I am also almost fully in cash at the moment. Not so much out of "fear" of a crash as a belief that the risk/reward ratio favours being out of the market for now. The summer months are seasonally weak and to me there looks to be little upside with the chance of a fairly large down move. The probabilities favour being out at the moment IMHO.
My view is that the markets will still be there in a years time, or ten or a hundred or even a thousand years, but I may not be if I blow up my account. Avoiding risk is more important than worrying about missing out. There will be plenty more opportunities in the years ahead.
Very wise words Ben.
I think the worst case of ‘groupthink’ I've seen is the collective ramping of CloudTag on bulletin boards and Twitter. It was like watching a slow motion car crash and unsurprisingly it ended in tears for holders.
It appears to me that a minority of pump and dump merchants are making money off naive investors who are looking to "get rich quick". Sordid and sad.
For me, to be a successful investor you have to do your own research and make your own decisions, you can't look to others for affirmation. The problem is that people are lazy and want shortcuts to success - they don't want to put in the hours of homework.
Well written and very true
Can't argue with any of main article but here I am sitting on lots of cash convinced it is only a matter of time before the bear rears its head and I am very bored-- what mischief can I get up to? Perhaps I will write an article about how the stock styles exposed me to having two Sucker Stocks which I immediately sold, after all who wants to be a sucker? They were my best performers of the year one is down 10% since I sold the other up 40%. Perhaps I should go back to my old belief of how to be a success in the markets. Live in a dungeon with no radio, newspapers or TV listen to no one do the work and place your bet!!
Ken - About you sitting on lots of cash in anticipation of any retraces/crash you may feel are imminent. I am too! (Sitting on loads of cash). Bet some on here similar. In other words - Fear cash?
Had an email from one of the many free subscription sites in the US where the chief analyst gave his views on why he thought there WOULDN'T be a crash soon, despite the record breaking bull market we're all experiencing.
He gave his general reasons then presented his main argument - apparently in the US right now, Brokers and financial houses are sitting on huge amounts of uninvested cash like never before in the belief a crash is just around the corner.
His contention is that in other crashes there was no huge pile of cash investors had set aside in expectation of a crash and all that cash will be duly invested in due course when investors tire of waiting for "it" to occur and cited the huge cash piles as THE reason there won't be a crash.
Not saying he's right. Not saying he's wrong. But who else has tons of cash set aside uninvested besides you and I?
The market only looks bullish in nominal cash prices. Equities look relatively cheap in risk premium terms (yield relative to other asset classes). People can only make relative choices (between asset classes and consumption), so nominal prices can't matter that much ultimately.
Also how often in history has a crash been preceded by everyone saying "there's a crash coming". A bubble is when (almost) everyone is (frantically) optimistic.
The one thing no one has experienced is the low interest rates which is driving the man in the street to find a better return on savings. Consider that to get the same income from a £100K in 2007 you need about £800k today and that is without taking into account inflation. So you could say that the market is being driven up by the so called lucky older generation who have seen their income reduced by over 90% Whilst the unlucky younger generation have been able to borrow money at about a third of the rate ten years ago and a fraction of the 15% paid thirty years ago. Fund managers can't run to cash it isn't allowed beyond about 10% so the money flows have to be invested. Never ask a fund manager his view on the market he can't afford the truth. Now I am no economist but this interest rate bubble, well there is that word again, this interest rate bubble must be having an effect on world stock markets. If the FTSE yield was 3% when the bank rate was 5% doesn't something have to give when the FTSE yield is 3% when the bank rate is 0.5%. I just don't know what it is, so I will say the stock market, but then we could be in a new paradigm and we have heard that before. Bugger it I am back to the dungeon.,
Ha! Hee hee. Quote of the day. LOL!
Ken Lowe @ "..Never ask a fund manager his view on the market he can't afford the truth...."
good article, apart from the negative effects on bias, they are also a draw on time and energy. They also satisfy so many of the cognitive biases exposed in risk based investing : I like the attached Codex as a summary of the many forces one is exposed to when investing/trading.
In classical knowledge management, establishing a Community of Practice (CoP) can be a powerful mechanism for accelerated learning and sharing. That is predicated on some qualification of "practice" and expertise. Moderated forums led by thought leaders with quality control on content and behaviour are likely to be more successful: a good example is probably the SCVR discussion threads around Paul and Graham's reports. Their expertise provides content and context which facilitates discussion. It probably still gives rise to group think but at least it is fact-based opinion with multiple inputs.
Most of the other non moderated forums and bulletin boards are shark-infested ramp tanks for the unwitting. They do seem to enjoy some success in pump and dump scenarios though that depends on one's perspective.