“Investing in speculative assets is a social activity,” said Nobel laureate Robert J. Shiller in the first line of a paper published 40 years ago.
It is somewhat ironic that just as George Orwell’s 1984 eerily foresaw the rise of pervasive surveillance and state control, the U.S. economist’s 1984 paper presciently anticipated the GameStop phenomenon. Trading in the video game chain’s stock demonstrates how social dynamics and mass psychology can override market fundamentals to drive speculative frenzies.
A recent study that looked at the impact of social dynamics on retail investor trading behaviour helps to quantify how these social influences affect performance. And what it found is not good.
One of the key aspects of the research was to look at something called “upward social comparison.” This is the tendency to compare ourselves with someone who appears to be doing better: Paging Keith Gill, a.k.a. Roaring Kitty.
The man most squarely linked to the GameStop trading frenzy that gripped headlines during the lockdowns posted a screenshot showing a US$53,000 stake in the company in September, 2019. By April, 2021, his reported GameStop holdings were roughly US$31-million.
He returned to social media a few weeks ago after a three-year absence and stated his GameStop positions were now worth over a quarter of a billion dollars. His YouTube livestream on June 7 garnered more than 600,000 concurrent viewers and was also covered live on business news television channels. He is the poster child for upward social comparison in an investment context.
In the study, participants were divided into two groups: one group was presented with information about top traders, while the other group served as a control. All participants were screened to include only those with a “higher level of financial knowledge.” The researchers then used a dynamic trading simulation that mimicked trading activity on real-world online platforms to observe the participants’ behaviour.
The results were striking. Investors exposed to the performance of top traders took significantly more risk, traded more actively and had higher overall trading volume compared with the control group. This suggests that even financially literate investors are prone to having their trading strategies influenced by a combination of emotions and cognitive biases when exposed to information about superior peer performance, leading to herd behaviour.
The study also revealed that the participants who traded more extensively yet failed to match the best traders’ performance viewed their effort as wasted, leading to decreased satisfaction with their own performance. As the researchers note, “Our findings demonstrate the pitfalls of modern investment platforms with peer information and social trading.”
The market for investing services has evolved to take advantage of social investing dynamics through various forms of social trading where investors copy the trades of other retail investors.
In some cases, such as in Canada, social trading is facilitated through information sharing on forums like WallStreetBets on Reddit. Positions and trades are also shared on social media accounts on TikTok, Instagram and Youtube. Other use this information to mirror these trades in their own portfolios.
In other jurisdictions, social trading is completely automated, and big business. For example, eToro, a trading platform operating in multiple jurisdictions around the world, advertises a “copy trader” feature which allows you to have your account execute trades that mirror another user on the platform in real-time in proportion to your account size. Once you choose an investor that you like, you click a button and your account will automatically execute trades on a continuing basis.
The most copied investor on the platform is a former management consultant who manages his portfolio full-time, but in effect also manages US$77-million of other people’s money – he has 23,700 followers on the platform who mirror his trading activity. eToro’s website states that their copy trader program does not amount to investment advice. (I can feel the eyes of portfolio managers in Canada popping out of their sockets.)
However, as we’ve seen with social media, the ability to build a large following and the soundness of advice offered are not necessarily correlated. That doesn’t matter much when it comes to finding a fun place to eat on a Friday night, but it matters a lot when it comes to your life savings.
The study’s findings serve as a wake-up call for investors and regulators alike. As social trading platforms continue to evolve and potentially expand into new markets, it’s crucial that we understand the potential risks associated with these platforms and take steps to mitigate them.
Preet Banerjee is a consultant to the wealth management industry with a focus on commercial applications of behavioural finance research.