Social media has become a very important communication tool for almost everyone over the past decade. And especially since 2020, the investment community has taken advantage of the speed and broad reach of social media to exchange helpful advice and breaking news. But it turns out that these tips aren’t as helpful as investors might think.
Financial experts in the European Union have found evidence that debunks any notion that stock investing tips on social media will lead to incredible gains. While they can be useful for catching the occasional one-day surge, researchers say there is little evidence to support social media’s ability to generate long-term returns.
Social media does not lead to big stock market gains
A committee of researchers from the EU’s European Securities and Markets Authority released a research report this week detailing the link – or lack thereof – between stock recommendations on social media and investment returns.
Researchers found that, starting in 2021, there was a notable increase in the number of stock market discussions 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 a sharp increase in the stock price. As a result, a short squeeze ensued. Traders – particularly from hedge funds – who had previously shorted the shares were forced to close their positions to limit further losses, thus causing the shares to rise further. The social media-fueled effort attracted international attention and eventually led to the Hollywood film “Dumb Money.”
While the “meme stock” craze is behind us, the use of social media to spread stock tips has remained widespread.
On the one hand, the report found that it exists AND a correlation between these stock mentions on social media and short-term excess returns, “suggesting that the spread of information on social media platforms influences investors’ trading choices and can amplify short-term financial market movements,” according to the relationship.
However, the data also shows that these stock tips largely don’t work to produce noteworthy long-term gains. Any positive effect of social media interactions on stock prices lasts about a day. Therefore, research suggests that social media hype around a stock leads to an immediate increase in stock prices, most likely because investors see the positive sentiment and jump on the bandwagon, which increases trading volume and can push prices higher in the short term.
However, these tips don’t equate to significant long-term returns, meaning they’re not something investors should take seriously for growth investing.
An important aspect highlighted by the authors is that, unlike specialized financial media sources, sentiment on social media is uncontrolled and free of accountability. Therefore, in addition to stock recommendations that do not result in substantial long-term success, investors must also deal with the fact that many of these recommendations spread by social media are misinformed or false.
In this sense, the risk of investing based on social media sentiment is even greater.
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