Your favorite social media guru is probably a bad stock picker

One of my favorite parts of 2020 and 2021 was the emergence of the “finfluencer” (finance influencer) on social media sites like Twitter, Reddit, and StockTwits. These influencers ranged from anonymous accounts, who, perhaps once a month, tweeted higher quality breakdowns of under-covered stocks than you’d find in JPMorgan’s equity research department, to Wall Street Bets regulars who posted stock charts, poorly constructed “technical analyses,” and rocket ship emojis. 

Some finfluencers wrote about their favorite stocks behind paywalled Substacks, often justifying negative margins and 50x revenue multiples with high top-line growth. Meanwhile, dozens of “trading groups” pumped their favorite penny stocks, believing that a “not financial advice” disclaimer would protect them from any legal issues (and, in at least one case, they were right).

Of course, the influx of finfluencers led to an important question: do their recommendations outperform the market? Thanks to the Swiss Finance Institute, we now know that the answer is “No.” In fact, the majority of stock market influencers actually generate statistically significant underperformance.

Last year, Ali Kakhbod, Seyed Kazempour, Dmitry Livdan, and Norman Schürhoff published a paper on their findings after studying the performance of more than 29,000 StockTwits finfluencers. This abstract is just gold:

Tweet-level data from a social media platform reveals low average accuracy and high dispersion in the quality of advice by financial influencers, or “finfluencers”: 28% of finfluencers are skilled generating 2.6% monthly abnormal returns, 16% are unskilled, and 56% have negative skill (“anti- skill”) generating -2.3% monthly abnormal returns...

The advice by antiskilled finfluencers creates overly optimistic beliefs most times and persistent swings in followers’ belief bias. Consequently, finfluencers cause excessive trading and inefficient prices such that a contrarian strategy yields 1.2% monthly out-of-sample performance.

After four years, we now have proof that, yes, fading stock market gurus is a profitable trading strategy.

However, while finfluencers, as a group, generated negative returns, the researchers saw that a minority actually generated abnormally high returns. Sadly, these skilled ones had smaller audiences:

Less active finfluencers with fewer followers are more likely to be skilled. Skilled finfluencers are return contrarian; they make positive tweets after negative returns and negative tweets after positive returns. Skilled finfluencers are also social sentiment and news contrarian; they make fewer positive tweets when social sentiment is positive and more positive tweets after negative news. Similarly, they make more/fewer negative tweets when social sentiment is positive/negative and fewer negative tweets after negative news. More tweeting after high trading volume and, in particular, negative tweets on short-sale constrained stocks also indicate the presence of skill…

Antiskilled finfluencers ride return and social sentiment momentum. They make positive tweets after positive returns and negative tweets after negative returns. Antiskilled finfluencers are more/less likely to make positive/negative tweets after positive social sentiment. Antiskilled finfluencers are also less/more likely to make positive/negative tweets after negative news.

Basically, most finfluencers’ recommendations actively underperformed the market, but a minority of posters outperformed. The issue is that followers failed to accurately identify the skilled traders.

Intuitively, it makes sense that worse traders would have bigger followings. Skilled traders will make money regardless of their audience size, so they don’t need to self-promote. Unskilled traders, on the other hand, need large audiences to make money, because they are either selling stock picks to their followers, or they using their followers as counterparties.