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April 18, 2013 10:08 am

Markets Insight: Wake up to the #Twitter effect on markets

Investors need to spend more time thinking about the way social media can affect financial markets

How does crowd psychology affect financial returns? That is a question economists have been pondering ever since traders first huddled in physical trading pits, dealing floors or around computer screens. And this week the issue has become doubly relevant, given how markets in gold – or even Bitcoins – have gyrated.

But now some data scientists are jumping into the fray as well. Two academics at the MIT media lab in Boston – Sandy Pentland and Yaniv Altshuler – have been crunching vast quantities of computer data to track what happens to investors plugged into social media, such as Twitter.

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Gillian Tett

This marks a curious new frontier for investment research; though economists have always been able to track market returns, the advent of social media – and big data – means researchers can now track investment returns alongside information flows, with growing precision.

And the results from this analysis are intriguing. The MIT research (which has not yet been fully published) suggests that investors do not perform most effectively when they are isolated from social groups. The image of a brilliant, maverick trader sitting alone, shunning conversation to make winning individual trades is wrong. But neither do traders outperform when they are embedded too deeply in any one market group (or chat room) be that the gold bug community, Japan watchers, Bitcoin enthusiasts, or anything else.

Instead, the best returns occur when investors are plugged into diverse social groups that enable them to collide with information from multiple networks. In the social media world, as in real life, it pays to hover on the edge of cliques – but not get slavishly sucked into just one.

The tool the MIT analysts used to measure this behaviour was a trading platform known as eToro. This site was created 15 months ago to capitalise on the trend among individual investors to use social media to swap trading tips and news.

But eToro does not simply enable traders to chat about markets; it also lets traders “follow” each other, by monitoring other investors’ trades, discussing them in an open forum and, crucially, by copying them too, automatically if they choose.

Thus people can build a trading strategy on the back of market chatter, or by mimicking a successful fellow trader (or “gurus”, or “tribal leaders”, as Yoni Assia, the chief executive, calls them).

Tribalism in any form tends to breed tunnel vision and echo chambers, in cyber space as much as the real world

Now, luddites who hate social media – or who have never watched people “flock” in cyberspace, to use the phrase coined by Biz Stone, Twitter’s co-founder – will find the thought of following a tribal trading guru bizarre. It might also look downright foolish, given that classic investment theory suggests the best returns occur when people trade on information not freely available to the crowd.

Yet 2.7m traders have flocked to eToro, performing over 40m trades, and other similar sites are springing up.

When Pentland and Altshuler conducted studies on those eToro investors, using different control groups, they found that this received wisdom about crowd behaviour did not hold true. “Social traders” who received information from a wide variety of social groups – and copied a range of gurus – performed 10 per cent better than “normal” traders. Those “socially aware” traders also performed about 4 per cent better than traders following one or two gurus.

The MIT researchers are doing additional analysis. But the pattern that is emerging is clear: maintaining diverse social ties – and swapping information with several different crowds – tends to raise returns.

And Pentland, Altshuler and their colleagues think they can project the optimal level of diversity. They have devised a system that deliberately mixes up the information flows and tweets traders receive, to create a sense of variety, and that apparently boosts returns by 209 per cent.

So what should anyone make of this? One implication is that investors or regulators need to spend more time thinking about the way social media can affect financial markets.

A couple of weeks ago, the US Securities and Exchange Commission made one (belated) step in that direction: it declared companies are now allowed to distribute information via Twitter if this is part of a pre-announced policy.

But there is far more that needs to be done, as social media grows in influence.

The more basic lesson is we also all need to reflect on the type of information we use in our own lives (or investments). The pool of traders Pentland and Altshuler studied is a relatively small, self-selecting group. But their tendency to huddle in cosy cyber tribes is not necessarily that unusual: we all like to stick with ideas or people who reinforce our views.

But tribalism in any form tends to breed tunnel vision and echo chambers, in cyber space as much as the real world. And that has a nasty habit of creating market manias and investor losses. Just ask that bruised tribe of Bitcoin enthusiasts, or those goldbugs.

gillian.tett@ft.com

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  1. Report Sandokan | April 19 11:16am | Permalink
    Tett, u enlighten my days with ur MIT accademic papers . Their latest discovery ? There is pluralism in the markets opinions. O Lord ! How much did they spend to come to this conclusion
  2. Report Procyon Mukherjee | April 19 4:48am | Permalink
    Response to a wide range of stimuli when attention is irrationally directed, while inattention on fundamentals mounts, the response to such influences can at best be randomly directed towards outcomes. The human mind also has to grapple with sequential information with different weights; do not see how without research being directed towards this, any amount of inference could be any better than random selection.
  3. Report gazmac | April 18 11:57pm | Permalink
    more on social trading...

    http://www.moneyob...ing-leader-can-pay
  4. Report HopeSprings | April 18 8:34pm | Permalink
    Gillian, I presume you don't imply that there is any value in trading per se?

    I think the safest approach is to have a clear and sound judgement of the ultimate values of things, and to avoid dabbling in anything where you lack this insight. That's harder than it sounds.
  5. Report PETER | April 18 8:23pm | Permalink
    Did they use an Excel spreedsheet?
    Gillian....you arnt on twitter??????
    Twitters quite useful as a news feed, but success using social feeds/groups to divine beneficial information, may be more nuanced than is suggested
  6. Report Daniel 21 | April 18 6:33pm | Permalink
    It goes without saying that getting around and listening is a good policy in life and Ms. Tett's article is a good reminder of that. Most of us do tend to listen to what we agree with already, and the Internet can misead us into thinking we're cruising the information highway when in fact we're travelling the same local digital roads over and over.

    But beyond that, I think she and the MIT people are over-investing in the magic of an open-to-all Twitter feed. Would she like to define "tribalism"? As for Bitcoin, does she know what happened to it? And does she know why people buy gold? It seems to me that it's not in either case a product of "tribalism", "tunnel vision", or "echo chambers", but of a deep mistrust of fiat currencies and/or frustration at having to park money in a (haircut-prone?) bank for zero percent interest or thereabouts in an age of inflation.
  7. Report Karl Marx | April 18 5:47pm | Permalink
    And what does society gain from this? Nothing, I would say...
  8. Report europhile | April 18 4:34pm | Permalink
    There may be a lot of data but the time series is too short. For any data on trader differentiation to be more than trivially interesting, one would need to have data over decades. Otherwise, the data from social networks is bound to reinforce the notion that social networks are important.
  9. Report Doogie Hauser | April 18 4:33pm | Permalink
    @Tony Tassell, point taken, I must have just picked the journos who were not tweeting. Good to see so many of you on twitter. Why aren't the rest?
  10. Report Tony Tassell | April 18 3:37pm | Permalink
    Dougie Hauser...you might be surprised...there are quite a lot of us online...here is a sample list of some of main tweeters https://twitter.co...ournalists/members
  11. Report J J | April 18 1:48pm | Permalink
    No doubt the central point about social media use and trading success is interesting, but be careful about being seen to endorse "follow me" trading platforms, which have a history and prospect of controversy on the basis of transparency and platform errors. Blind pursuit this week of a guru on the basis of last week's performance defines dumb money in the casino.
  12. Report Doogie Hauser | April 18 1:45pm | Permalink
    actually, after a bit of research seems that quite a few #FT journos are on twitter, but many have never tweeted and their accounts appear dead.

    any chance of tempting Gillian et al into making a mark on the 21st Century's favoured means of rapid news communication?
  13. Report Doogie Hauser | April 18 1:40pm | Permalink
    why so few #FT journos using Twitter?
  14. Report @JayGeraghty | April 18 12:48pm | Permalink
    Gillian, wonderful article and a pleasure to read. Thank you. Tbh Twitter is crying out for a Tett MIT PhD account. Looking forward to your next article on #bitcoin #beyondQEperpuity #beyondcapitalism
  15. Report knackeredhack | April 18 12:12pm | Permalink
    Diversity trumps complexity. Unfortunately, this has been poorly understood, not least in journalism.
  16. Report EdV | April 18 12:05pm | Permalink
    So, the best investors are people leading normal lives, neither blinkers-wearing geeks, nor social misfits. How encouraging. But did we not know this already?
  17. Report GSo | April 18 11:37am | Permalink
    The fox and the hedgehog have moved from analysing security policy to analysing securities, and the fox comes out on top here as well.
  18. Report Pieter, Netherlands | April 18 11:14am | Permalink
    Very interesting
  19. Report Ex big 4 long time Partner | April 18 10:59am | Permalink
    A very good article, fascinating and thought trovoking. Thanks!
  20. Report Wriggley | April 18 10:46am | Permalink
    Selectively Herded Easily Eluded Proles

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