Why You Should Think Twice Before Taking Stock Tips From Social Media
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Social media has become a very important communication tool for most everybody over the last decade. And since 2020 especially, the investing community has taken advantage of social media’s speed and wide reach to provide each other with hot tips and breaking news. But it turns out that those hot tips aren’t as useful as investors might think.
Finance experts at the European Union found evidence that dispels any notion that social media stock investing tips will lead to incredible gains. While they may be useful for catching the occasional single-day rise, researchers said there’s little evidence to support social media’s ability to generate long-term returns.
Social media doesn't lead to big stock market gains
A committee of researchers with the EU's European Securities & Markets Authority published a research report this week detailing the link — or lack thereof — between social media stock tips and investment returns.
The researchers found that, since 2021, there's been a noticeable increase in the amount of stock market discussion on social media. This began around the time of the infamous GameStop stock fiasco, during which retail investors coordinated a mass investment in the company's stock in a concerted effort.
In the case of GameStop, this caused the price of shares to rise sharply. As a result, a short squeeze ensued. Traders — specifically at hedge funds — who previously shorted the stock were forced to close their positions to limit further losses, thereby causing shares to rise even further. The social media-fueled effort drew international attention and ultimately resulted in the Hollywood film, "Dumb Money."
While the "meme stock" mania is mostly behind us, the use of social media for spreading stock tips stuck around.
On one hand, the report found that there is a correlation between these stock mentions on social media and excess returns in the short term, "suggesting that information spreading on social media platforms influences investor trading choices and may amplify short-term financial market movements," according to the report.
However, the data also shows that these stock tips largely don't work for producing long-term gains of any note. Any positive effects of social media interactions on stock prices last about a day. So, research suggests that social media hype around a stock does lead to immediate price pumps for shares, most likely due to investors seeing the positive sentiment and hopping on the bandwagon, which increases trading volume and can drive prices higher in the short term.
However, these tips don't correspond to any significant long-term returns, meaning they aren't something investors should take seriously for growth investing.
One major takeaway which the authors point out is that, unlike specialized financial media sources, social media sentiment is unvetted and lacks accountability. So, in addition to stock tips not translating to substantial long-term success, investors must also reckon with the fact that many of these social media-borne recommendations are misinformed or disingenuous.
In this sense, the risk of investing based on social media sentiment is heightened even more.
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