Crowdsharing investment leitmotifs

Appealing communities of investment clubs were born on the internet, as social media platforms focused on sharing stock ideas.  This is in some ways similar to facebook or twitter, but aimed at the trading and investment culture.  A number of these platforms have grown and thrived.  Howard Lindzon runs one of the most steady and popular among them, StockTwits.  Invited to his investment conference, we could appreciate the large fan base and technology ecosystem that augments the investment news and social media industry.  For the many who are involved in the securities industry, the need to tap into a large and data-rich business model has a constructive function for these many constituents (and for hundreds of my former data science students as well).  We examine this topic below, and what some of the value drivers are in using free online resources to develop trading and investment ideas.

It’s fair to start with some initial and practical theory.  Some, such as myself, can build a broad and balanced global asset allocation with inexpensive funds (I use Vanguard).  There is rarely a good reason to diverge from it.  The heart of asset allocation is based on using this grounding, and then taking infrequent and small positions in areas one feels offers pricing inefficiencies.  For example, when Federal Reserve Chairperson Yellen’s comments today indicated a worry about excessive stock prices, the personal investment read-across is to underinvest in some of just the equity portion of your portfolio (not use put options as your complete portfolio’s position!) 

Of course, there are many rationales as to why this Black-Litterman style of active portfolio management is optimal, though some of the assumptions can breakdown in reality, as we saw during the financial crisis.  On the flip side, there are also several reasons one might find themselves owning significant amounts of individual securities.  One could have been granted stock awards at a company where they work.  Or they want to comply with a career regulation to recues themselves from interest in a previous industry.  For example, when former Treasury Secretary Paulson wanted to not have his Goldman Sachs interest enriched by policy choices. 

Or, wash-sale rules that restrict sales on one security for tax reasons, so an analogous security may be shorted instead.  Or one wants to hedge their overall human capital through life by underinvesting in their individual income source (since they labor almost completely in that risk factor, their personal investment should be completely detached of it, particularly for those far from retirement – here, here).

Even for people who typically have a broadly passive investment approach, the thirst for investment and market knowledge can be high.  It could be news.  Entertainment.  Or simply education.  The ability to tap competing perspectives can enrich our life experiences.  In general, we find that our consumption of information should come from three equal buckets.  The first bucket is in the form of self-generated research.  One of the best ways to learn is through one’s own research and experience.  Writing research to share on LinkedIn or similar is a wonderful method to share ideas and increase your knowledge simultaneously.  The second bucket is in the form of digesting opinions that are like your own.  Sharpen your own pre-existing biases by hearing what others have to say.  This could be read in academic research or articles shared by friends, attending conferences (some are run by investment personalities such as Ritholtz or Scaramucci or the media such as Delivering Alpha), talking to finance professionals, etc.  And the third bucket is to appreciate what those who have different points of view have to say.  Alternate among business news.  Reconcile your thoughts and ideas with the best alternate viewpoints.  Again, this is easy to do with the ample research ideas out there.  Reading articles on the internet is one of the best ways.

Crowding ideas does have some nuances to it from a theory perspective.  The first is that there is often a concentration of parallel and common ideas.  The pressure to agree - even imperfectly - sometimes takes over.  As noted to me by CFA official Will Ortel, this occurs even among investment committees at large banks where disagreeing with a senior member is discouraged (also true in the Federal Reserve).  By democratizing investment ideas, more new ideas can get out.  Some of the leading fintechs are based on this premise.  And there is various research to show that within a few people (and degrees of freedom), one limits the amount of all the knowledge that they get on what’s out there.  You may learn >60% of all there is to know by simply talking to a small number of friends (here, here, here).  Only those with truly large and diverse opinion bases get to see a richer variety of information on which to draw from!  Engaging with a broader audience, forces your own ideas to reconcile to a much more demanding contour of counter-opinions.

Now there are some risks to balance out the positives of using socially crowded investment ideas.  These are theoretical risks, and not those associated with trading in perhaps obscure tickers (though among the most common “hashtagged” tickers on these sites are the large index ETFs, followed by day-trading high-beta stocks).  One risk is from the crowded groupthink mentality, where everyone dumbly guesses in the same direction (e.g., Brexit won’t happen, Trump won’t happen, etc.) and meanwhile they fail from their inflated sense of confidence.  It is mathematically impossible for everyone to agree and exit from a bubble at the top!  When it matters the most to know when to get in or out of the market, the wisdom of the crowds can’t foretell when the crowd itself is also irrational en masse! 

But during normal market periods there is comfort in vetting ideas from a variety of like-minded investors.  It’s a challenge to determine the impact of this risk, but there is also genuine comfort in knowing the theory of complementing a long-term basket of asset classes with a strong complement of individual securities to one’s portfolio.

Another risk of these platforms is the ease in spreading false news (with or without malice) and not always really knowing where information is coming from.  It is not always clear whether the quality of the information consumed is valuable for sound investment advice, or simply made up information to fit a recent price trend (which in the end should be benign but for liquidity risk).  Obviously, this risk also applies in all sorts of MSM research, and academic research isn’t always fully valuable either (note few finance professors retiring early).  An astute individual would be wise to search out different opinions and have a solid understanding of the risk of the security, regardless of the “news” that others may share on it.

For example, if one were to invest in a new technology stock based on a fundamental driver or accounting valuations, it’s still important to understand the general covariance of the stock and industry to the rest of the market and how the market patterns in one country relate to asset classes around the world.  These drivers are important, in case one’s thesis doesn’t work out it’s important to know the other comprehensive drivers of the stock price moves.  And as for reading an ongoing amount of information, it’s been noted that even the world’s savviest people such as Warren Buffett and Elon Musk read hundreds of pages of research daily.  Other than this website, what do you suppose they are reading?