On social media platforms, investors are able to share information, opinions and views at a large scale in real time. The quality and validity of information shared by individuals in that way cannot be taken for granted. In this respect, social media posting differs fundamentally from journalism: specialized financial media are held accountable for the accuracy of the information they report. This is not necessarily the case for social media.
The impact of social media information in securities markets is, therefore, a growing market and public policy concern. Increasing social media interactions and related sentiment among investors influence the collective investor behavior with potential effects on financial market dynamics. This comes with notable risks for retail investors raising investor protection concerns. It may also involve wider market movements with systemic implications, increasing financial stability concerns.
Against this background, the European Securities and Markets Authority (ESMA) in a recent Trends, Risks and Vulnerabilities (TRV) analysis investigates the influence specifically of social media activity and sentiment on stock prices. The main findings identify only a transitory effect of social media sentiment on stock excess returns. Positive social media sentiment seems to be correlated with higher returns in the very short-term. In this sense, information spreading on social media platforms may affect investor trading choices and may amplify daily market movements.
However, price overreaction typically does not last more than one day and is only transitory. This points to the risk of investors excessively relying on social media news whose truthfulness and accuracy is difficult to verify. With this analysis, the article authors cast a first light on the market impact of social-media information in the EU. Other transmission channels and market impacts are likely to exist, and more analytical work and monitoring need to be undertaken to obtain a fuller picture of the risks for individual investors and markets at large.
No Gamestop, but…
The emergence of new infrastructures, such as online broker platforms and trading apps offering low (or zero) fees, have facilitated access to financial products. Investors are now able to share information, views and their own investing and trading behavior at a large scale in real time and can quickly process transactions on their apps.
Considering the large number of users and the amount of information circulated, this could also result in collective interdependent behavior. This behavior is mainly based on emotions and in-group psychology rather than advice based on economic fundamentals (e.g., herding behavior). Eventually, this may have implications at a more systemic level increasing financial stability concerns.
The most recently observed example of this is the Gamestop frenzy, in January 2021, characterized by extreme price volatility and substantial retail investors’ trading. Some retail investors were caught up in the hype surrounding the stock, making impulsive and uninformed decisions without fully understanding the risks involved. This reveals significant investor protection issues. So far, we have not observed similar events affecting the EU retail market. However, 80% of the EU population makes use of social media. This is a massive proportion, with a higher concentration among younger generations.