Social Networks for Stock Picking? - Give me a Break

Today TechCrunch had a piece on a company called socialPicks, whose tagline is “Putting a Face Behind Every Investment Idea,” and which labels itself as “…a community for stock market investors.” TechCrunch provides more details on the socialPick’s raison d’etre:

Users enter their stock trading activities and thoughts then befriend and rate other users. Reputations are built according to a user’s percentage of winning picks, quality of insights as judged by the community and number of trades made. With commenting, feeds and a list of popular stocks that looks like a tag cloud (just charming really) this site has got most of the requisite features of a standard social network. SocialPicks believes that an emphasis on individual reputation instead of aggregate information will prevent much of the gaming that critics of social stock sites often critique.

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The company is also of the belief that many people want an easy way to share their knowledge with a small group of their friends in a structured way. They are aiming for a del.icio.us model more than a digg model, they say. That’s the main part of their approach that prevents pump and dump activity, they plan to institute activity monitoring that will notify users of suspicious behavior as well.

Needless to say, there are variety of other sites trafficking in this space (with confidence-inducing names such as Feeling Bullish, Bullpoo, Gradr, Stocktickr and Digstock). I don’t know if I’ve been living under a rock or something, but this whole social-networking-for-stocks phenomenon has completely passed me by. And for good reason. It’s both stupid and potentially dangerous.

It is particularly interesting to read some of the comments to the TechCrunch article. The diversity of comments pretty much represents that of the investing public - most comments have no appreciation for history or empirical research, a few are so far off the reservation (citing “wisdom of crowds” as the reason why such sites make sense) as to hardly warrant comment while a few actually raise the fundamental issues of indexing, risk management and diversification. The feel one gets from looking at these sites is that investing is somehow supposed to be FUN. For those of you who have lived in the markets for a long time, we all know this to be the kiss of death.

Investing life should not about being the next Jim Cramer - or if it is, may the force be with you. Investing in equities for long term profits is HARD, and unless you are professional (and, I might add, one of the few rare professionals whose record is empirically proven to be due to something other than pure chance), then it is best to get out of the way and to focus on the one thing that really matters to building and preserving personal wealth - asset allocation.

I could cobble together an entire research paper on this topic in an afternoon if I had the time, but the core principles off the top of my head are as follows:

1. “Wisdom of crowds” is the right concept in the markets, including the equity markets, and it already exists - it’s called a stock price. Whatever makes you think you know better regardless of what some of your pals think is completely beyond me.

2. Asset allocation accounts for 90% of investment return across a diversified portfolio, e.g., picking the components making up the each of the building blocks accounts for only 10% of the portfolio return. Read: it’s all about asset allocation, stupid.

3. Investing is not a game and shouldn’t be viewed as a source of entertainment. If it is then call it what it really is - gambling. That’s ok - use your brain and focus 95% of your efforts on 95% of your portfolio (meaning choosing asset allocation and using indexes to achieve your portfolio objectives) and mess around with 5%. Just know what you are doing and label each of your activities for what they are - investing and gambling.

4. Unless you have a staggeringly large data set it is almost impossible to attribute a stock-picker’s success to skill and not luck. I wrote an entire post on this concept several weeks ago, and I encourage you to take a quick peek. Someone’s posted results on a social networking site (even if verified as true and as having happened by members of the site) may or may not be indicative of that person’s skill. The issue isn’t necessarily the veracity of the claims (which is the big argument made by these stock social networking sites), but whether the claims are statistically meaningful and indicative of skill. If this is a game you want to play, good luck.

I spent over 17 years on Wall Street in M&A, Derivatives and Trading, and I personally don’t feel comfortable trading single stocks. Because I’m stupid and don’t understand the markets, valuation, and “the Game?” No. Because I am humble and aware of the barriers to success. If you want to play games and have fun on these sites, go ahead. But if you want to be an investor and increase your chances of building and protecting wealth, it is decidedly not fun and it’s serious business. No fooling.