Using Social Media to Lead to Better Trading

“The influence of social media on financial markets is here to stay, as younger generations start saving and investing,” write Claudia Biancotti and Paolo Ciocca in a white paper issued by the Carnegie Endowment for International Peace. “This carries both opportunities and risks.”

Biancotti and Ciocca note that while sharing information on public platforms “can improve market transparency and efficiency … social media platforms are known vehicles of disinformation and manipulation of human behavior” that “could be weaponized by malicious actors.”

Over at Charles Schwab, Randy Frederick, managing director of trading and derivatives for the Schwab center for financial research, offers some tips for how traders can use social media to their advantage without being taken advantage of.

While refining your stable of Twitter sources, it’s important to actively weed out self-interested and misinformed accounts without excluding the legitimate viewpoints. So, before clicking the “follow” button, Frederick suggests asking if the source has a solid track record, if the account has been verified, if the account’s perspective is informed or dogmatic, and if it challenges or reinforces your biases.

Pay attention to the stocks that people are talking about online — not just to find immediate trade opportunities, but to spark new ideas or reconsider existing positions.

Social media posts can prompt a trader to, for example, review volume trends for a popular meme stock after a tweet provides evidence that it could be falling out of favor, revisit a potential trade candidate after the company shares a press release revealing that its technology failed to deliver on its promise, or investigate why a company withdrew previously issued earnings guidance.

Social media posts can be helpful in providing information, but they should only be used as a catalyst for further research.

When Reddit users drove up the share prices of AMC Theatres, GameStop, and other underperforming stocks last year, the social media platform showed the power of the crowd. While it’s good to keep an open mind when trying out new trading approaches, it’s also important to be skeptical of stock performance driven by social media.

The attention of a social media platform can push up a stock’s price beyond what’s expected, but it can also make it difficult to properly identify reasonable profit and loss targets. If social media hype has driven a stock’s price two, five, or even 10 times higher, an analysis of that stock’s fundamentals will likely reveal that it’s overpriced and overbought. When taking a position in a trending stock, make sure to have an exit strategy in place, and be wary of taking too big a position.

“At its best, social media is a source of limitless trading ideas—so long as you separate the wheat from the chaff,” Frederick writes. “And no matter which tips you ultimately choose to pursue, be sure you do so for the right reasons. In a world full of get-rich-quick schemes, the opportunities you don’t go after can sometimes be as advantageous as those that you do.”

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