How Social Interaction Propagates Active Investing

 

Interesting study about trading and social network

The Dedicated and the Dabblers: How Social Interaction Propagates Active Investing

Our analysis of a new dataset on the activities of retail foreign exchange traders who are participants in a social network supports our hypothesis that social interactions promote the growth of active investment strategies. We apply a population evolution model in which strategies are transmitted through communications between investors and their adoption is motivated by the promise of high returns. The model predicts that the average individual employs increasingly active strategies so long as the propensity to reveal one’s strategies is increasing in realized returns, receivers of communication increase their trading intensity in response to hearing of higher returns, and the volatility of returns for those who are characterized as being active traders are greater than those for whom are not. We confirm the predictions of the model by documenting two novel empirical findings: on average, individual investors are more likely to initiate communications with other investors the greater their returns and they increase their trading intensity upon hearing of good returns.

While in most standard theory the flow of information within networks leads to better performance among market participants, we find that communications between investors may reinforce and even promote reckless trading behavior. This is largely driven by bias found among traders in which they develop forecasts of future returns that are merely extrapolations of the recent performance of assets. This leads them to follow strategies with occasional outstanding results, but that are less protable on average.