Posts Tagged ‘Francis Galton’

You may or may not think Twitter and Facebook are worth your investment bucks, pennies and cents, but it does appear that investors plugged into certain social media services often enjoy better returns.

Gillian Tett at the ‘FT’ broke the story, but actually, it should not come as a surprise. Ms Tett focused on the work of two MIT academics: Sandy Pentland and Yaniv Altshuler. After analysing a mountain of data, they found that investors who are plugged into a diverse range of investment groups enjoy the better returns.

They found that investors who work on their own often perform least well. Those who follow one or two investment gurus do better, but not as well as those who follow several such gurus. But the best performing group are those that just follow a diverse and large range of other investors covering a wide range of specialities and interests.

Pentland and Altshuler focused on a trading platform called eToro. The service itself describes itself in these terms: “Social Trading is about opening the markets to everyone. At eToro we encourage people to connect with one another to discuss, trade, invest, learn and share knowledge across the network. From now on, you don’t need to be a pro to trade like one.”

But this is not the first research of this ilk. Last year Johan Bollen and Huina Mao of Indiana University and Xiao-Jun Zeng of the University of Manchester found that investors who tap into the public mood often enjoy superior performances. They also found that Twitter is a good gauge of such mood. See: Can Twitter predict the stock market? 

Fashion: it is not a concept many investors like to admit to, particularly those who suggest that investment is a science, but truth be told stocks rise and fall with fashion. Sometimes shares rise because the crowd has decided they are going to. On the back of crowd behaviour we got the dotcom bubble, gold rising and falling and bitcoins – for example.

There is a flaw with the idea of wisdom of crowds. Studies show that crowds can be very smart, BUT when and only when the individuals who make up the crowd work in isolation. The classic study was carried out by Francis Galton in 1906, when he surveyed visitors who entered a competition for guessing the weight of an ox at a livestock fair. Galton found that the average guess was very accurate, and so the concept of the wisdom of the crowd was born.

But the crowd in the Galton study had one characteristic that we rarely see in practice. Each guess was made in isolation and was not subjected to the influences of what others thought. Psychological studies provide overwhelming evidence that we all tend to comply with the crowd.

Ten million.

How tall do you think the author of this article is? Take a guess, go on.

Studies show that if the number ‘ten million’ quoted above had been lower, say four, instead of ten million, your guess as to the writer’s height would have been much lower. It sounds ridiculous, but it is true.

That is the point; we are all influenced by each other in surprising and often quite unintuitive ways.

If you can gauge the mood of the crowd, you would indeed have an advantage in predicting stock market changes. By plugging into social media we become a part of the crowd, but maybe we can understand it better too.

There is a snag. Crowds can get it horrendously wrong. The individuals who make up a crowd copy each other. But there is always a limit. A crowd can persuade itself to back an idea beyond that point when its support is rational.

By plugging into the crowd you may be able to second guess fashion in investment, but you may also get swept along, and when the bubble bursts you will find little comfort in the fact that you share one thing in common with the crowd – a lost fortune.