Investors, it pays to get social with your enemies

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There are a few things that can really rankle investors: Losing money, missing out on gains and seeing opinions that oppose your own.

Well, maybe we should relax on that third point. Gillian Tett at the Financial Times has an interesting piece on Thursday discussing the results from an academic study looking at how social media impacts investor returns.

The gist of it: Traders perform far better when they are not entrenched in any one particular group but rather expose themselves to diverse opinions.

As Ms. Tett puts it: "In the social media world, as in real life, it pays to hover on the edge of cliques – but not get slavishly sucked into just one."

The analysis, which hasn't been fully published, was done by Yaniv Altshuler and Alex Pentland at the MIT Media Lab in Boston. They used a trading platform called eToro, which allows investors to not only communicate with each other but also copy one another's trades.

Or, as eToro's promotional bumpf says, "You choose which top traders to copy, then sit back and let the magic happen. Every trade they open is automatically copied in your account letting you benefit from the best traders abilities without you even breaking a sweat."

Mr. Pentland and Mr. Altshuler found that traders who followed a range of social groups and trading "gurus" performed 10 per cent better than those with a far narrower following. They believe traders are "prone to much riskier behaviour when following their peers, and are much likely to overreact when their peers are doing so and the market is uncertain."

This conclusion doesn't mean that investors should go with the crowd – a potentially dangerous strategy that can lead you to chase trends. Rather, it implies that investors should base their decisions on a variety of ideas, even if they conflict. In other words, gold bugs should hang out with gold haters, and Apple fanboys should listen up to the Google crowd – and vice versa, of course.

The initial conclusions could be a boon for social networking in general, not to mention specific sites like eToro's. As Mr. Altshuler told Quartz in mid-February: "This study will show that by wisely using a network as a medium for exchanging information, you can generate a non-zero sum game. This creates a synergy where all of the participants are winning together. That's the goal."

The problem is if investors take this goal as a reason to commit big bucks to short-term trades. It is one thing to conclude that diverse opinions lead to better investment decisions; it is another thing entirely to conclude that social networking will make all day traders exceptionally rich.

The other problem is that nifty patterns tend to disappear very quickly as more people notice them. A recent research paper by David McLean at the University of Alberta and Jeffrey Pontiff at Boston College looked at dozens of stock market anomalies discovered by academics – and found that returns declined substantially after the anomalies were published.

As Michael Santoli, a columnist at Yahoo Finance, noted: "New technology can make an investor better than he or she was, or otherwise would be, but not necessarily better than the rest of the people also trying to extract returns from markets using similar tools."