Social investing sites

Introduction

Social investing sites are community-based web sites where investors post their opinions about stocks they think are buys or sells. These opinions are aggregated and every stock is then ranked using the investors' collective opinion as a sentiment indicator. Every investor also has their ratings (and overall return) tracked. And users can also rank (and track) the best investors (or track any investor that a particular user is interested in following).

Most of the social investing web sites are based on fake-money stock picks, but the more advanced sites integrate real-money trades, either by connecting to the user's brokerage account, or because the broker itself offers social investing functionality (such as Zecco and TradeKing).

It should be noted that "social investing" sites, where investors aggregate their opinions about stocks, is a completely different area than "socially responsible investing" (also known as "SRI") where investors only invest money in ethical companies and avoid investing in companies which engage in socially irresponsible activities (alcohol, tobacco, gambling, etc).

History of social investing sites

Marketocracy, created in 2001, was one of the first web sites created with the express purpose of aggregating and tracking investors in order to find the best ones. A few years later, in 2006, Motley Fool decided to leverage their already-large userbase to create their Motley Fool CAPS community where Fool users could share their stock picks. Around this same time, the "web 2.0" business model which utilized user-generated content became very popular, partially due to venture capital flowing into the industry. This led to the creation of many new social investing sites, such as Cake Financial, Covestor, SocialPicks, StockPickr, Vestopia, and BullPoo.

Although most social investing sites concentrate on specific buy and sell prices for stocks, there are a few which concentrate in certain niches.

WikiInvest is the only social investing site to concentrate on solely pure research where users post analytical information about different companies and industries.
Collective2 (also known as "C2") is another unique social investing site because it focuses on mechanical trading systems.
StockTwits, one of the most popular social investing sites, is one that has leveraged the Twitter business model to become successful.
eToro and Currensee, are both sites which concentrate specifically on forex traders.

The social investing sites that offered real money tracking of portfolios initially received a lukewarm response from the investing community because so many people were concerned with the security of their information when it came to connecting to their real-money account. But those worries seemed to have gone away. Today, some sites, such as Tradency, even offer "mirror trading" where you can have your account automatically execute trades based on other traders' strategies.

After so many of the stand-alone social investing sites became popular, online brokers realized that they were missing out on the trend so they many of them jumped into the game. Online brokers had an obvious advantage because they already had a large userbase of traders, so they didn't need to build a userbase. They also didn't have to worry about the security risks of allowing third-party companies accessing users' real-money information because it was done in-house. All the brokers had to do was integrate social investing functionality directly into their own sites. A few of the more popular broker-based social investing sites are the TradeKing Trader Network, ZeccoShare, and MyTrade, which is part of TD Ameritrade/ThinkOrSwim. Scottrade and E*Trade also have less-popular communities.

As competition in the sector grew, there was inevitable consolidation. StockPickr, started by James Altucher, was bought out by thestreet.com. Some of the weaker sites closed. Cake Financial was bought out by E*Trade and was promptly shut down. Vestopia seems to have disappeared for some reason unknown to me. Since the success of social investing sites is based on the "network effect", there will likely be more consolidaton in the future.

Social investing sites that focus exclusively on currency markets are popular simply because there are fewer markets to choose from, which makes it easier for users to form tighter social groups. The currency markets only have about 5 to 10 major markets which most currency traders monitor. The stock market, by contrast, has over 10,000 stocks, which leads the social stock investing sites to be a much more fragmented community.

My Opinion

Social investing web sites are one of the most useless resources available to investors, for many reasons. Some of the reasons are due to the design flaws of these sites, while others have to do with execution:

(1) The purpose of social investing sites is to create an arena where investors can aggregate their individual opinions in order to create a collective consensus, which can then be used to gain an advantage. But we already have an arena where a collective consensus is calculated - the stock market itself. These sites' key success factor is scale, but paradoxically scale is also the factor that will make these sites useless because if the sample size of users gets large enough then the sites will BE the market.

(2) Social investing sites reinforce the instinct of amateur investors to look to other investors for answers. Successful investors aren't successful because they follow other people's ideas and strategies. These social investing "communities" reinforce dependence on others and tend to be nothing more than security blankets for most users. In a BusinessWeek article about social investing, someone named Jim Collins, a TradeKing user stated:

"Just the fact that I'm seeing people in there buying calls and common stock has definitely given me confidence that the individual is buying on the dip, which is basically what I do, and it's always good to get some reassurance that other people are doing the same thing."

Similarly, in a MarketWatch article:

“Trading by yourself is a lonely thing,” said Dave Lemont, chief executive of Currensee, who says that collaboration can be valuable. “You can validate your ideas.” And, he said, you can commiserate over bad trades.

Sorry, but I don't agree with this kind of mentality. I tend to do worse when I listen to other traders, and the times where I do seek out other people's actions is usually when I am doing badly.

Ironically, the desire to gain a better return by mimicking other investors' actually leads to the exact opposite outcome. I've seen some writers (mostly financial planners) state that "investing isn't a contest." Well, it actually is a contest if you are choosing individual stocks, whether you want to admit it or not. A positive alpha for one investor must come as a result of a negative alpha from another investors, and making investment decisions that are in line with the majority of other investors leads to definitively average returns. Users of social investing sites harbor the naive opinion that all investors can sit around holding hands, singing Kumbaya, and make higher-than-average returns.

Even the successful traders you follow may end up not being helpful in the end. One of the benefits of social investing sites is that they offer up-and-coming talented traders a chance to build their reputation by building a successful track record in real-time and under the public's eye. But the truly talented traders will probably eventually move on to charging for their services. They too may be offering their advice out of self-interest in order to build their personal brand.

(3) Fake-money trades don't mean much at all. Being first on a list of paper traders only counts for so much.

(4) The research derived from these sites is very low-quality because very few of the users explain their rationale for buying a stock. This means users don't actually learn anything, which is what is most important.

(5) The overall quality of information on social investing sites is very low because of the sheer volume of information available. Whenever I search through a social investing site, I just see a blizzard of stock symbols, dates, and ratings without any meaning. Social investing web sites have one of the lowest signal-to-noise ratios of all investing resources.

(6) Social investing sites may reinforce bad habits. If you follow a successful trader, they may condition you to think that making money in the market is easy. Or if you are a successful trader yourself, it may keep you from doing valuable research and keep you from concentrating on trading.

(7) The investors who are most likely to post their investing opinions on social investing web sites are more likely to be bad investors. Most readers may think this is because successful investors are not interested in giving up their edge. I think a better reason is that successful investors simply have better things to do. The users of social investing sites, on the other hand, generally value talking more than learning. To a large extent, social investing web sites are just a more sophisticated version of the stock message boards of the 1990s like Silicon Investor and Yahoo Finance.

There has been some research done by Aite Group which shows that investors who use social investment networks earn higher profits by following successful traders. Their research showed that 50 percent of users of forex social investing firms were profitable, compared to 30 percent of US traders using traditional brokers. I do admit social investing may offer benefits under certain circumstances. For example, autotrading will be more successful than subjectively following successful traders because you have your own decision-making processes (which are probably bad) eliminated. Also, currency traders with successful track records will probably be more likely to maintain success than stock traders, given that the currency markets are simpler. I do, however, think that the overall benefits of social investing sites are vastly overstated.

Users of social investing sites should realize that these sites were created for business reasons. Because I am a webmaster myself, I know that the majority of these sites were created by entrepreneurial webmasters who simply wanted to cash in on the popularity of the new "Web 2.0" business models that utilized user-generated content. I myself had an idea for a social investing web site before any of the others came out. I didn't end up creating it because (among other reasons) I didn't think it would actually help investors - and I wanted to spend my time trading. Similarly, the brokers who have created social communities for their customers benefit from the higher volume of trades, even though they try to convince everyone of the benefits of these communities for their customers. In an article in BusinessWeek, Tom Sosnoff, president of thinkorswim.com stated:

[I believe] the reason people are communicating on thinkorswim.com is to learn how to be more effective traders, not to gain a sense of community for its own sake. "We build trading networks. Really what it is, we build technology that drives domain knowledge. The way you do that is you provide a network for customers to interact with you, as well as with each other," he says.

eToro, a popular currency-trading web site, promotes the tagline, "Social Trading - the smarter way to trade".

Sorry, but I disagree. I think improving financial literacy rates is a better solution than teaching people to simply copy other people. There are some other people who are signaling caution when it comes to the risks (and usefulness) of social investing sites as well. In a MarketWatch article, Lynn Ballou, managing partner with Ballou Plum Wealth Advisors LLC said:

“It doesn’t seem to matter to me whether it’s in a cool technology wrapper or a cool social wrapper, it’s still a basic investment and a basic personal-finance matter...We need to strip away the razzmatazz, so to speak, and just analyze it logically and figure out what it really is.”

In another article about social investing, Matthew Klein, chief executive officer at C2, says that it is important that social investing sites promote responsible investing, or else amateur investors might suffer large losses. "It does concern me a little bit that people are opening Forex accounts at very high leverage without really understanding what that means," he said.

To be fair, the industry is responding to these concerns. Yoni Assia, the CEO and founder of eToro, says the eToro trading platform has features in place to make sure inexperienced investors do not take inappropriate risks. Specifically, they do not allow people to follow gurus with more than 20 percent of their account balance.

The future of social investing sites

One of the obvious predictions is that social investing sites will become much more popular. Industry experts are predicting exponential growth over the next few years and are predicting that the number of social investing site users will grow into the tens (or hundreds) of millions. While it's entirely possible that this may come true, it's also possible that the opposite may become true - that the popularity of these sites will fade. These sites may become fads. Most investors, after all, tend to be very private with their information. They don't like to publicly admit their losses.

The whole category of social investing sites is very young, and many social investing sites still don't know exactly what they want to be and do. Some of them seem like they want to focus on research while, at the same time, want to segue into managing money (since that is more profitable). They also seem like they have been focused on just building their brands and userbase while not focusing so much on their strategic purpose. It's possible that these sites may morph into helpful resources in the future after they become more focused, but for now I recommend people don't waste their time.

The few social investing which have grown to become respected sites (such as Marketocracy) have expressed plans to manage real money portfolios based on the theoretical premise that their highest-rated users will outperform the market averages. There have been a few instances where well-respected researchers decided to get into the money management business. A couple of well-known examples are Martin Zweig's Total Return mutual fund and Motley Fool's foray into mutual funds. The resulting performances have tended to be disappointing. As the years go by, I think it will be interesting to see if the theory of these social investing outperformance is validated.

It's also possible that if social investing becomes popular enough, it could become regulated due to the fact that investment recommendations are being communicated to the public, and some trades are even being executed based on these recommendations. It doesn't help that the investors who taking advice from others on the internet are less-educated (financially) than customers at full-service brokers. The current environment of social investing reminds me of the hedge fund environment back in the early 1990s. Back then, nobody cared about hedge funds. But as hedge funds became more popular (especially among the masses) there was pressure to regulate them so novice investors wouldn't get hurt.

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Social investing sites

Introduction

History of social investing sites

My Opinion

The future of social investing sites

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