The Growth Of Social Media And The Financial Market

Social media has transformed society in many ways, some of which have not been for the better. For example, social media has been linked to worse mental health because it amplifies harmful social comparisons. Research in the area of financial markets unexpectedly finds that many of social media’s main drawbacks also affect the behavior of amateur traders, often to their own detriment.

Financial markets and the way people trade have traditionally been thought of as largely rational processes driven by changing fundamentals like earnings reports or economic indicators. However, others suggest that the stories people tell each other—i.e., narratives—are more important than economic fundamentals in driving economic outcomes, such as asset price bubbles. Recent research, such as some of my own, shows that social connections between traders increasingly influence investment decisions in important ways.

This research on the effects of social media on trading behavior comes from newly available data sources. One such data set observes the activity of thousands of retail traders who were members of an online social network allowing researchers to connect traders’ portfolio returns and trading behavior to their messaging and friendship connections over time. Another data set comes from a social media platform designed for sharing ideas between traders. Several key findings have emerged from this research:

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1) Others' success led to aggressive trading: When traders' peers had positive portfolio performance in the past week, they tended to trade more aggressively in the following week themselves, often unsuccessfully. As a result of this social transmission bias, traders’ average activity increased and the volatility of portfolio returns also trended upward as the social network grew over time with more traders joining.

2) Broadcast gains, hid losses: Traders were more likely to privately message other traders on the platform following weeks when their own portfolio had high returns. In other words, traders preferred to spread the word about their wins rather than their losses. Traders on social media platforms are also likely to seek confirmatory information, for example, other traders who share bullish views on a stock.

3) Traders, just like most other people, engage in impression management strategies on social media: While traders like to talk about their investment successes, they also disappear when their trading goes poorly. Naturally, traders like to present themselves as winners because of the social stigma associated with losing. As a consequence, our research finds that social media amplifies the behavioral bias known as the disposition effect whereby traders sell winning assets too quickly and hold their losses too long.

Taken together, these results suggest that social media enables the selective sharing of investment "success stories" which can propagate more risky, active trading strategies even if most traders ultimately underperform. The natural human tendency to follow the crowd and learn from others' successes, amplified through online networks, may be shifting the culture in finance toward greater short-term thinking.

As financial markets become increasingly globally connected by technology, continued research on social influences could help shed light on how interactions shape decision-making and ultimately, market outcomes. Understanding these “social transmission biases” will grow in importance.

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