As the market adjusts to our new reality, we discuss whether the changes we’ve seen are a result of an inherent property of the stock market or a wave of unprecedented social media influence.
The latest hot stock market news stories have had a polarizing effect on new traders. While the opportunities are attractive, expert traders warn about the increasing volatility spurred by the accessibility of social media, and the dangers of the lack of gatekeeping.
Future of Wealth Head Trader, Lance Ippolito; WealthPress Senior Investment Strategist, Jeff Yastine; Dr. Sergey Savastiouk, CEO and Founder of Tickeron; and Alpha Intel Chief Investment Officer, Adam Sarhan weigh in on how social media is interwoven into the fabric of the market, the foreseeable consequences of this tandem, pyramid schemes, the democratization of finance, and give advice to novice traders.
The Influence of Social Media
With the increasing influence social media has on retail traders and investors, comes a responsibility to keep track of many things at once.
Dr. Sergey Savastiouk recaps the situation with the new paradigm: “In this social media environment, we found ourselves in a predicament where the government and the SEC doesn’t have the means for quick action. The frequency and the magnitude of the recent ‘pump-and-dump’ activities were significant, and Robinhood, as a private company, had to react before receiving government guidance. If Robinhood did not react, the situation would have escalated further, resulting in potentially catastrophic circumstances. By halting investing in stocks like GameStop, Robinhood protected themselves and their users, including the inexperienced beginner investors that did not understand the gravity of the situation. Where Robinhood mis-stepped was the lack of transparency and their explanation of the decision to halt the investing in those 13 stocks. Robinhood should have explained their decision in the throes of the volatility."
The speed with which changes happen in the market is one factor.
The time it took large groups of investors to hear about a stock, do some nominal research, and then buy the shares used to take months. This time was condensed to a few weeks with the introduction of the early internet. Smartphones whittled that time to just a few days. Robinhood and other platforms have strategically coaxed new traders into treating the process as a gamble, egged on by the opportunity to receive on-the-spot tips and answers from StockTwits, Reddit, and Twitter.
“That’s both a blessing and a curse,” says Jeff Yastine. “A blessing, since it can magnify a big move in a stock to matter of a few days or weeks. It’s a curse since you may not be ready to pull the trigger on a stock while you do more research - meanwhile other investors have already piled in and run the shares far past where you wanted to buy.”
This new, potentially misleading information breeds an excessive amount of chaotic movement, as traders are subject to knee-jerk reactions. This creates a niche for clever investors who can locate a disconnect and make profit off an advantageous position that others might have missed.
However, Lance Ippolito is cautious: “I would say one of the major benefits social media has had for the average trader is its ability to level the playing field. Keep in mind, social media influencers are posting charts on stocks daily where just the posts via social media can now move a stock. Before, if you wanted quick market news that could move a particular stock, you’d have to pay thousands of dollars for a service like a Bloomberg terminal, wait for someone to publish the info or know someone with connections and info on the inside... Now you can get that info instantly!”
“Pump-and-Dump” Scheme vs. Democratization
Instant information is certainly all the rage – but is social media-influenced trading a creative new pump-and-dump scheme?
“So far, the impact is nothing more than a short-term run up that will flame out and pass,” Adam Sarhan assures. “It will crash back down to earth once the novelty fades. I wouldn’t touch any of these stocks with a ten-foot pole.”
Yastine agrees: “Somewhere down the road, the virality has worn off and they sell and move on to the next fascinating-stock of the moment. Rinse, wash, repeat.”
Ippolito believes that is a recurring cycle that has been going on for many years.
“It just so happens these mentioned lower-traded stocks became a larger group because they’re highly shorted. But this is no different than institutions and hedge funds picking certain groups of large cap stock stocks.”
So then, if what we’re seeing is simply more of the same, and nothing particularly new, then are we even on the path to the democratization of finance?
That depends on how you define democratization.
“Anyone who wants to - even with only literally a few dollars - can participate in the stock market via Robinhood and micro-shares of stock. Anyone who wants to...can buy shares in IPO-type startups via SPACs,” Yastine underscores. “Playing the markets was originally a game intended for the elites only. Now we’re at a time where we’re seeing the little guy join in. I can now see groups being able to keep up with hedge funds, especially in options. I can have a group of 10k people on social media and these folks can go into a stock looking like a big institutional buy.”
“I think we’re at that point now where finance and the stock market has been democratized.”
Ippolito is skeptical. “Going all the way back to the early days of the stock market, we’ve seen short squeezes. There’s no way finance will ever end its corruption or become a level playing field.”
Many believe that a significant part of this corruption stems from the consequences of using commission-free brokers, such as selling trader information for profit, or selling order flow to competitors. The crux of the matter is that while some traders care a lot about this, while others are content with making a profit by any means.
“In the same way that many of us are happy to allow Google to store and gather data on us in return for free email accounts and other popular services, I think a lot of new investors could care less that Robinhood’s backers are using free trading to gather data on their investing activities,” Yastine postulates.
Ippolito and Sarhan argue that built-in corruption within the market allows for such unethical practices, which makes it impossible to truly level the playing field.
The bird’s eye view on this is as follows: pump-and-dump schemes akin to what we’ve seen are not news to experienced traders. They advise novice traders to be careful and stay away from highly volatile asset classes like penny stocks and alt coins. The same new traders who might not have experienced a bear market may find themselves unprepared as the market evens out or corrects to lower levels.
“Eventually, the forces helping to drive the stock market effortlessly higher will fade out for one reason or another - rising interest rates, rising oil prices, fear that the Federal Reserve may not be so supportive as vaccinations make the pandemic fade away, etc.,” warns Yastine.
Technology investing, in particular, is cyclical in nature.
“When the cycle turns, it can be devastating if your still holding shares of a stock that may still have a great product, but the shares have long since discounted that company’s rapid growth rate - and the rest of the investment community has moved on to companies with rapid growth but a lower stock valuation,” he adds.
As a result, it makes sense that aspiring traders should steer clear from squeezing shorts.
“The key is to buy the stocks early -- before they surge in price. Not after a big move,” confirms Sarhan.
Ippolito whittles the point down to its basics: “Every time you go into a trade, think about what you could lose. What would your maximum loss be and how much money can you afford to simply give away?”
As a trader gets acquainted with the market, utilizing fundamental and technical analysis correctly makes it easier to step away from a gambling mindset. In general, it’s important to stretch as the market adapts to new realities. Opinions differ as to whether the market truly changes as it adapts. Some presume the adjustments made to accommodate new conditions are made with the intention to revert back to preliminary conditions as new traders become less trigger-happy with their strategies and settle into long-term planning.
Yastine ties the two together: “The stock market is always changing, because people are always changing - boldly acting one moment, running and hiding in fear another.”