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Ignore Investment Tips from Stock Message Boards

Sell IBM today.
In fact, sell it now. $131.80. It ain't gettin' better than that.
Life is great.

Sentiment: Strong Sell

This confident and cheery posting on Yahoo! Finance on August 9, 2010 is from anonymouse1. Who is that, you ask? Well, it could be anyone, just fill in the blank with your own desired reality. A seasoned and successful investor...a loose-lipped insider...or simply someone who likes to chat and share opinions?

While many investors are flocking to virtual message boards and communities (41.4 million visitors to Yahoo! Finance in May 2010), four researchers warn that the boards are actually detrimental to investors.

Prabhudev Konana and Bin GuPrabhudev Konana, Alok Kumar, Raj Raghunathan and Bin Gu are Ph.D. researchers in marketing, finance and information systems at The University of Texas at Austin and the University of Miami. They claim message boards cause good investors to make bad decisions.

"It's not as simple as saying, 'Well, it is harmless entertainment,'" says researcher Kumar. "There is real risk you will be influenced by the 'noise' and begin to amplify your own investment biases."

The pros and cons of crowd sentiment

The problem is not accuracy of the information. Prior studies have shown virtual communities are often more accurate than analyst forecasts (Enron's collapse was first reported on message boards). Recognizing value in crowd sentiment, PredictWallStreet, Marketwatch and others have started to aggregate investment sentiments from message boards and blogs for professional investors.

So what is the danger?

"Individual investors exhibit what is called confirmation bias," says Konana. "They select and read information that conforms to their own preconceived biases, and as a result they actually become more confident in their opinion and trade more frequently, but with lower overall returns."

This runs counter to the concept that investors are rational information gatherers. "Behavioral finance studies tell us investors are subject to all manner of psychological biases," he says. "And message boards contribute to these biases, actually amplifying them, particularly for investors with strongly held opinions."

Bears grow more bearish, bulls turn even more bullish, and trading frequency rises, along with greater trading cost. So these four researchers say, "Just ignore the boards, it's as simple as that."

Research specifics

Using data from a stock message board (sanitized to protect investor identities), the researchers studied how investor behavior changed in response to their use of message boards. Volunteers were solicited from users of Naver, the largest online portal website in South Korea. After the volunteers completed a survey about their investment behavior and opinions, the researchers followed the users' patterns of accessing posts on the site, and their degree of acceptance of the advice. It was found that the investors tended to click on messages consistent with their prior beliefs, and to accept opinions with which they already agreed.

"Other studies have shown similarities in investor behavior across cultures," says Kumar, "So it is reasonable to expect that the results can be generalized to other markets, including the United States."

Confirmation Bias, Overconfidence, and Investment Performance: Evidence from Stock Message Boards

Authors:

JaeHong Park
Prabhudev Konana
Bin Gu
Rajagopal Raghunathan

Alok Kumar

Comments

#1 this is so helpful..i m happy

this is so helpful..i m happy that i read it

#2 The concept that investors

The concept that investors are "rational information gatherers" plainly runs contrary to all experience, and not just as regards on-line chat. Aside from confirmation bias, there is also a problem that people are "followers" of whatever a consensus may be, while the market favors some degree of contrarian thought.

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