Chapter 10 – Collective Intelligence, Social Media, and Web Market Monitors

Web Market Monitors and the Impact of Social Media on Financial Markets

“The words of the prophets are written on the subway walls.” — Simon & Garfunkel, The Sound of Silence

Opinions vary widely on the value of collective wisdom, with ample supporting evidence both for and against. The Internet has many positive examples: The collective ratings at consumer sites like Amazon for books (and almost anything that can be shipped in a box), Newegg for electronics, and Yelp for restaurants are almost always reliable when there is a strong consensus among a large crowd. When 95 out of 100 people say a software program doesn’t work, it is probably no prize (and the other five likely work for the publisher). When 250 out of 275 people rave about the latest Asian Cajun(1) spot and the waiting line winds around the block, dinner is not likely to be too bad. When every other customer complains about meeting a man with a stomach pump, you’re better off packing your own lunch.

Markets themselves are a form of collective intelligence (CI), and since transactions occur, they clearly arrive at prices seen as fair by buyers and sellers alike for everything from stocks to Pez dispensers (the first eBay merchandise). A recent book by James Surowiecki, The Wisdom of Crowds: Why the Many Are Smarter Than the Few and How Collective Wisdom Shapes Business, Economies, Societies and Nations (Random House, 2004) has nearly 300 pages of examples of group wisdom. One such example is the television quiz show Who Wants to Be a Millionaire. Contestants are asked a series of increasingly difficult questions, worth increasingly large payoffs if answered correctly. At any point, they can take the money and run or proceed to the next level.

If they are stumped, contestants are allowed to choose among a “lifeline,”(2) calling a friend, and polling the studio audience. Friends have provided the correct answer 65 percent of the time, but the audience has been right on 91 percent of the questions they’ve been asked. This is clearly an unscientific approach, since the friends and the audience have been given different questions, but it does suggest the value of collective intelligence, particularly for perky blond quiz show contestants.

That is not the case for the oft-repeated “guess the number of beans in the jar” experiment, popularized in finance circles by Jack Treynor(3) and repeated endlessly at financial conferences. A typical result was that when the jar contained 850 beans, the average estimate of the 56 students in Treynor’s class was 871, and only a single student had a guess better than the collective. This game is not anywhere near as popular on campuses as beer pong, but it is still played with the same kind of positive “wisdom of the collective” result.

In contrast, H.L. Mencken, the author, reporter, and editor known as the Sage of Baltimore, wrote, “No one in this world, so far as I know, has ever lost money by underestimating the intelligence of the great masses of the plain people.” Charles Mackay’s Extraordinary Popular Delusions and the Madness of Crowds, originally published in 1841,(4) supplies ample evidence to support Mencken’s thesis.

Modern Extraordinary Popular Delusions and the Madness of Crowds

The best known events are the Dutch tulip bulb mania, when sufficiently exotic bulbs (stripes were big) sold for more than a house, and the South Sea Bubble, when utterly worthless securities came to dominate the financial markets. Imagine something like that happening today. One anonymous Amazon reviewer concisely summarizes Mackay: “Why do otherwise intelligent individuals form seething masses of idiocy when they engage in collective action? Why do financially sensible people jump lemming-like into harebrained speculative frenzies — only to jump broker-like out of windows when their fantasies dissolve?”

Both schools of thought are correct, depending on the situation. Mencken and Mackay have nothing good to say about collective intelligence, but Surowiecki writes: Groups work well under certain circumstances, and less well under others. Groups generally need rules to maintain order and coherence, and when they are missing or malfunctioning, the result is trouble. . . . While big groups are often good at solving certain kinds of problems, big groups can also be unmanageable and inefficient. Conversely, small groups have the virtue of being easy to run, but they risk having too little diversity of thought and too much consensus.(5)

It is worthwhile to take an economic and game-theoretic view of this. When people have an incentive to be truthful, most of them will be truthful. When there is a reward for deceiving others, people will be deceptive. The studio audiences at Who Wants to Be a Millionaire and the bean population guessers have no reason to lie. In the case of the beans, the winner often gets to keep the jar or some other swag. For product rating scores, people feel good taking a whack at companies that sell some of the junk that passes for software and the like, and they earn a psychic payoff by sharing their positive experience with others, without risking or incurring any penalty for doing so. Scarcity issues are rare. For a restaurant reviewer, there is a slight disincentive in that raving about your favorites may result in long lines, somewhat offset by the feeling that since the half-life of new restaurants is about six months, you are helping your favorites to stick around.

If there is scarcity and competition involved, the incentives for the collective can be quite different. It becomes a game where at least some players will see a positive reward for providing false information.

Investing with Crowds: Stock Message Boards, Stock Tips, and Market Manipulation

Unlike restaurant or shopping advice, collective stock recommendations on message boards and “share the love” investment sites are examples of situations where deceit can be profitable. Holders of long positions in a stock have a powerful incentive to drive up its price, and those with short positions have a powerful incentive to drive it down, irrespective of the actual merit of either position. The anonymity of the Internet and the ability to create multiple identities make this easy to do.

As long as this looks like opinions being shared and does not cross over into outright fraud, the Securities and Exchange Commission (SEC) will not come knocking on an opinion sharer’s door. Many Web denizens do cross the line into criminal manipulations (some of the most egregious examples are described in the next chapter), but the distinction between the illegal and the merely malicious can be fuzzy.

During the tech bubble, a company called iExchange opened for business with a huge burst of PR, including segments on the major network news programs. The company T-shirts, which seemed to be everywhere in its hometown of Pasadena, read “BUY SELL” on the front and “TELL” on the back. It raised over $ 30 million from some of the biggest names in venture capital, and had one of the slickest social web sites seen up to that time. The home page from that site, , on June 20, 2000, is shown in Figure 10.1.

Figure 10.1 A profit of 1,200 percent in four months! Pretty soon these anonymous investment wizards will have all the money. Source: The Wayback Machine (, on the Internet Archive site at www.

Figure 10.1 The comment in the lower right column claims a profit of 1,200 percent in four months! Pretty soon these anonymous investment wizards will have all the money. Source: The Wayback Machine (, on the Internet Archive site at www.

The business model was that the first few tastes were free, and then investor users (like H.V., J.P., and I.G. over on the right) could pay analyst users (like “The Visionary,” “Big Jim,” and “Biotech Believer” in the middle pane) a modest fee, usually just a few dollars, for new research. iExchange got a piece of every transaction. There were $25,000 monthly prizes for the best stock picks, which was supposed to keep everyone honest.

The rating site for social web sites gave iExchange four stars, “a good place to make money.” The anonymous successful investors on the right are minting money. Surely they will be willing to pay the insightful analysts who let them reap these rewards? What could go wrong? Plenty. Perhaps you noticed that the screen grab is from the Internet Archive’s Wayback Machine, 6 the elephant graveyard of the Internet. Either those 1,200 percent returns weren’t enough to keep people happy or something went awry. The party ended, fittingly enough, just before April Fools’ Day in 2001, with the following sign – off, comprising the entirety of the iExchange site: …

>>>>>> READ MORE HERE < <<<<<<

All notes for this chapter about Investment Alpha and Trading Alpha from Wall Street Rumors, News, and Social Media:

1. Asian Cajun is an actual cuisine that is suddenly all the rage in the huge Los Angeles area Asian neighborhoods of Westminster, Alhambra, and Monterey Park. Those keen on elegant presentation may want to pass. This is a meal after which you wash off with a garden hose. Tasty variants on Cajun crawfish, shrimp, lobster, and crab are all served up, with your choice of sauce (spicy, greasy, or spicy and greasy), in big clear plastic bags dropped on a table covered in brown paper, with a roll of paper towels on the side. Paper plates and plastic forks are available on request. It’s much better than it sounds.

2. In Tina Fey’s dead-on parody of Sarah Palin’s interview with Katie Couric, the faux Palin asked “to use one of my lifelines, Katie.” She would have been better off asking to poll the audience. The funniest line in that skit, a long disconnected utterance that failed to parse as English, was taken verbatim from the actual interview.

3. Treynor is widely regarded as having been a shoo-in to have shared the 1990 Nobel Prize in economics had he only published a paper that was sitting in his desk drawer.

4. Still in print after 150 years (New York: Three Rivers Press, 1995).

5. James Surowiecki, The Wisdom of Crowds: Why the Many Are Smarter Than the Few and How Collective Wisdom Shapes Business, Economies, Societies and Nations (New York: Random House, 2004), xix.

6. Used in other chapters, this is a fabulous site founded to allow the historians of the Internet era to have something to use. The Internet Archive is at , and also has an extensive collection of nearly 400,000 free music downloads. Of these, 60,000 are live concert recordings, and 6,000 of those are of the Grateful Dead.

7. Entire contents of iExchange web site, March 29, 2001. Bye-bye, Big Jim. Source:

8. FTP is file transfer protocol, an Internet service that predates the World Wide Web and is still used for moving large chunks of information.

9. Landon Thomas Jr., “John A. Mulheren Jr., 54, Leading Trader in 80’s, Dies,” New York Times, December 17, 2003.

10. Ibid.

11. Michael Lewis, “Jonathan Lebed: Stock Manipulator, S.E.C. Nemesis — and 15,” New York Times Magazine, February 25, 2001.

12. Peter Wysocki, “Cheap Talk on the Web: The Determinants of Postings on Stock Message Boards” (Working Paper No. 98025, University of Michigan, 1999).

13. Werner Antweiler and Murray Frank, “Is All That Talk Just Noise? The Information Content of Stock Message Boards,” Journal of Finance 59, no. 3 (June 2004): 1259 – 1294.

14. Georgette Jason, who did the Dartboard articles for many years, says that while actual darts were thrown, they were never (as was alleged) thrown by monkeys. I went five rounds against the dartboard, using stocks selected by our quant methods, described in the chapters on seeking alpha and quantitative investing. I needed to explain why I’d picked a particular stock, and Georgette gently explained that “highest aggregate short-term forecast factor alpha” was too nerdy for WSJ readers. So I used to pick stocks near the top of our list that were amenable to having a better story back-filled as an explanation. For Home Depot (one of my winners) I explained that, having recently moved, I had personally dropped enough cash into the register to move the stock. Not keen on prison food, I never succumbed to the temptation to load up on a stock I’d picked before the story appeared in the paper. Rumor had it that not everyone in the game had the same dietary concerns.

15. Mark Hirschey, Vernon J. Richardson, and Susan Scholz, “How ‘Foolish’ Are Internet Investors?” Financial Analysts Journal 56, no. 1 (January/February 2000).

16. M. Bagnoli, M. D. Beneish, and S. G. Watts, “Whisper Forecasts of Quarterly Earnings per Share,” Journal of Accounting and Economics 28, no. 1 (November 1999): 27 – 50.

17. University of Maryland Human-Computer Interaction Lab,

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