Bloodbath. Armageddon. Crash.
As soon as markets begin to volatile you can bet that commentators are wheeled out to explain why it happened, what you can expect to happen in the future and what individual investors should do.
TV financial media is designed to entertain you, not necessarily to enlighten you with insight that will make you better at making the right financial decisions. Like any form of entertainment, financial TV is designed as an assault on your senses, with all manner of irrelevant information in which to overwhelm our cognitive resources. Financial media caters for the majority, it doesn’t cater for you and your specific circumstances. Remember, truth is harder to sell than fear. The question then becomes, is there anything better?
The move away from an information system based around vertical axes of trust (ie, conventional research and investment institutions), to one predicated on horizontal axes of trust (ie, Twitter and other forms of social media), has important implications for commodity and other financial markets. Although you could argue that social media (whether that takes the form of blogging or updates on networks like Twitter) democratises the supply of information, commentary and forecasts, it also forces the consumer of that information to swim through an ever increasing flood of viewpoints and commentary in order to weed out the gems. In turn, it leaves them open to the risk of information overload and of being overly responsive to the latest market updates.
In research published by Oxford University, entitled “Social Media, News Media and the Stock Market”, researchers found that the most talked about stocks on social media exhibited more volatility than those that did not. Although the research didn’t specifically look at commodity futures, it would not take too much of a stretch to imagine a similar impact here.
Despite the risks of information overload, maintaining a diverse set of information and views is likely to help raise returns for both traders and investors. Two academics at the MIT media lab in Boston – Sandy Pentland and Yaniv Altshuler – have been crunching vast quantities of computer data to track what happens to commodity and foreign exchange traders who are plugged into social media, such as Twitter. The MIT research suggests that investors do not perform as well when they are isolated from social groups.
The image of a brilliant, maverick trader sitting alone and shunning conversation to order to make winning individual trades is wrong. However, neither do traders outperform when they are embedded too deeply in any single market group, be that the gold bug community, oil market watchers or enthusiasts for any other commodity market. Instead, the best returns occur when investors are plugged into diverse social groups that enable them to collide with information from multiple networks. In the social media world, as in real life, it pays to hover on the edge of cliques – but not get slavishly sucked into just one.
Just as there is a danger in blindly following forecasts from renowned institutions, the MIT researchers argue that social effects are so strong that they sometimes over-ride individual’s rational assumptions. Individual traders are often prone to much riskier behaviour when following their peers, and are much more likely to overreact when their peers are doing so and market uncertainty is high. All of the commodity traders in the world (whether you are a physical buyer or seller or just speculate on the price of commodity futures) are organised into networks of friends, colleagues, contacts and others who are all sources of information and opinion and therefore influence. According to the concept of herding and imitation, commodity traders tend to imitate the opinions of their “neighbours” in their network, not contradict them. Social media may make this effect even stronger.
Oil is certainly the commodity market, perhaps along with gold, that gets the most attention from investors, but the impact of social media is far more widespread. The relatively private bulletin boards where the future of this or that commodity and the companies that produce them is still there; however, now you only need to search for a particular commodity or company and you can get a constant stream of unfiltered news and opinion. The trick is to spend enough time understanding each person’s agenda and track record in order to filter out the noise.
False hoods (ie, convincing narratives) can feed on themselves to take commodity and other asset markets well away from where the price should be. The occurrence of false trends is only likely to rise as global information and interpretation flow increases and narratives become more uniformed and accordant. Nassim Taleb put it well when he said:
The mind can be a wonderful tool for self-delusion – it was not designed to deal with complexity and nonlinear uncertainties. Counter to the common discourse, more information means more delusions: our detection of false patterns is growing faster and faster as a side effect of modernity and the information age: there is this mismatch between the messy randomness of the information-rich current world with its complex interactions and our intuitions of events, derived in a simpler ancestral habitat. Our mental architecture is at an increased mismatch with the world in which we live.
As information flows increase, it is now more important than ever to combine that with insight and knowledge. The commodity trader or investor of the future will find both on social networks. To this end, social media is something of a double-edged sword. According to Chris Berry of House Mountain Partners:
Most investors don’t have an adequate foundation of the multiple skills necessary to ask the right questions or interpret the answers. As a result, people end up in chat rooms making all sorts of claims. One of the best things investors can do is stay out of chat rooms.
So what should you do? According to Tadas Viskanta, author of “Abnormal Returns: Winning Strategies From the Frontiers of the Investment Blogosphere”, you basically have two options, “The first is to simply eliminate, or at least dramatically cut back on news consumption… The other option is to try and consume media in a smarter, more focused way.” If you as an investor, trader or producer or consumer of commodities have a time frame of more than several months, then there is a case for arguing that a media diet will help you. Nassim Taleb writes in his book, “Fooled by Randomness” that “the problem with information is not that it is diverting and generally useless, but that it is toxic.” On the other hand, as the success of most other diets testifies a media diet may not be all that successful either if it means you become less able to sift the wheat from the shaft.
And what about consuming media in a smarter, more focused way? There are two key aspects to this. The first is to focus on the best aggregators of information that are relevant to you. While this may result in you missing some bits of information, a competent aggregator of information should only highlight the information that is most relevant. Tadas Viskanta notes the value of following blogs, and here the market does a good job of working out who you should follow: “To a certain degree, the blogosphere is a meritocracy, an imperfect one for sure, but a meritocracy nonetheless. In general, the blogs that are consistently updated will find a growing readership.”
The final key aspect of consuming media more effectively is to be multi-disciplined and read widely. According to Oaktree Capital’s Howard Marks, “in order to be successful, an investor has to understand not just finance, accounting and economics, but also psychology.” That’s not just understanding the psychology of the market, but your psychology and also the psychology of the pundits and their inherent biases.
My recommendation? Do your own research. Learn from the best but rely less on the opinions of others when making investment or trading decisions. One way you can do this is by having a diary. Before you make an investment describe your reasoning in a decision diary that you can then refer back to at times like this when emotions can overpower rational thought.
This article is based on an extract from my new book, “Crude Forecasts: Predictions, Pundits & Profits In The Commodity Casino”.