Friday, March 24, 2006

The Internet effect 4 comments

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A reader of my earlier article had asked for my comments on the "word of mouth and the influential power of blogs and the Internet" in propelling certain stocks with upward price momentum. Well, I had talked about ways to use online forums effectively in an earlier article in August Using Online Forums but I guess I hadn't really talked about their power in mobilising support for a certain stock; such power seems to be in hold of the market nowadays.

And of course, another relevant piece of news on the Straits Times today: an online forummer on going by the nickname of Zhongkui has been charged with spreading false rumours on Datacraft being raided by the CAD in Feb 2004; that period coincided with the beginning of a downtrend in Datacraft's stock price to <$1 by the middle of 2004. I remember this forummer: he occasionally talked sense but seemed to get embroiled in feuds with other forummers once in a while.

Frankly, I think it would really be hard to prove that this Zhongkui was the source of the rumours, although he certainly helped to perpetuate it by writing about it online. In fact, it was reported that an OCBC Securities internal memo about this that was leaked out also mentioned this rumour, so it appears the rumour was quite rampant. The same BT news article also reported that "a spokeswoman for Datacraft told BT that the company has clarified matters with the person behind the Web posting and is unlikely to pursue the matter further". So.... obviously they reversed that decision, or perhaps the State decided to prosecute, as a deterrent to online pranksters. His prosecution shows that the authorities are not underestimating the power of the Internet in influencing stock prices (and in a prelude to many other matters as well, I believe).

America, that great proponent of free and unbridled speech, has not been shy in prosecuting such online rumour-mongers who have harnessed the power of the Internet to make personal gains. I remember reading about a student who was arrested for posting a false rumour about a dot-com stock on a bulletin board (as forums were known then) and then capitalising on the buyup by accummulating the stock beforehand. I mean, in the witchhunt following the dot-com bust, they even charged people for writing bullish reports about stocks that they did not fully believe in (even though these were mainly opinions, fully substantiated by facts) --- that's how Internet analysts like Henry Blodget and Mary Meeker got hauled up in court. The moral of the story is: you will get into trouble if you make unsubstantiated claims for the obvious purpose of personal gains, or even for wilful purposes (in the case of Zhongkui, assuming he did not short Datacraft).

Extending on my earlier analogy of stocks vs humans, it is clear that prices can be influenced by people's perceptions which are in turn a function of other people's opinions. That's where the Internet comes in, as the abovementioned reader has mentioned. It used to be that we had only the newspapers, chats among friends and with brokers (for the privileged few), and the ticker tape indicating buy-sell spread offered by invisible counterparts, on which to base our trading decisions. Now, with online forums, stock blogs (like mine), easily available online broker reports, even real-time trading platforms, the number of linkages with the entire investment/trading community is exponentially multiplied. One's perception of the value of a stock, if he is not careful, becomes an amalgamation of the multitudes of opinions of others that he has read, with his personal view being drowned among the sea of mutterings. Some observers feel the Internet might accentuate the herd mentality and cause crashes to be more painful and sudden, rather than improving market transparency. There is some truth in that view, which is why learning to separate the wheat from the chaff is becoming an increasingly important skill nowadays for stock traders who depend strongly on the Internet for news: they must know how to harness the immense advantage of convenience that is offered while shutting out the human tendency to listen only to things they want to hear (there's a scientific term for this: cognitive dissonance).

The power of the Internet in influencing opinions on stocks is, I feel, a function of four main factors. Firstly, in the midst of a market experiencing extreme volatility and emotions (such as a full-blown bull or bear), people are most susceptible to rumours and OPT (other people's talk), especially when the rumour reinforces the individual's view of the market/company. The 2004 rumour on Datacraft only reinforced views of a declining company making losses year after year, and it did not help that the general market, especially tech stocks, was apparently correcting (it turned out to be short-term) after a heady rally in late 2003. Secondly, the critical mass viewership of the Internet forum/blog in question also decides the "power" of the rumour/market talk. For example, DanielXX's stock blog would hardly be able to spread a rumour (even if I wanted to) effectively compared to say,, because the viewership for both is a difference of hundreds/thousands of times. Here I invoke Metcalfe's Law: the power or value of a network is proportionate to the square of the number of users. Thirdly, the authoritativeness of the forummer/blogger in question. Of course, broker reports carry the most weight, but opinions of established online commentators like Sage from Wallstraits and Oldman from Shareinvestor would of course carry more weight and greater credibility. Fourthly, and this is most worryingly, the frequency of postings on a certain stock can often drown out more reasoned voices. They say that bad money crowds out good, and the same for opinions too. I cannot help but notice two phenomena in this current bull market: hot stocks are talked about endlessly in forums with threads running to 30-40 pages long and further drawing in newbies who suck in all the crap, and secondly, people starting new threads on stocks that they are holding, which haven't participated in the rally, in the hope of rallying favourable opinions and drawing market interest to the stock. This draws my ire especially when these forummers don't provide any reasonable substantiation why the stock in undervalued; rather they just shout "Cheong" here and "Cheong" there.

Rather than fight against the trend of Internet talk becoming a way of life for stock trading/investment, one might as well swim with the flow. In addition to drawing in relevant and reasoned opinions, one can also take advantage of price extremes resulting from such forum-driven opinion swings to reel in good stocks at cheap prices (quite rare now, I must say). However, for every unfounded rumour, we must also take care to remember the possible flipside: no smoke without fire (cue ACCS, and recently, Noble).




Anonymous Anonymous said...

As always, great post. Just a few points to note.

First, I believe the opinions shared on online forums are more influential on thinly traded stocks and stocks where the majority are individual investors.

Second, Google has just introduced a financial news, stock quote and discussion board.

What makes Google’s financial site different is a list of blogs for each stock! It is now apparent that financial blogs are becoming mainstream. We will just have to wait and see if this new trend will influence investors' source of information. (blogs vs. conventional media)

In my opinion, if you own stock in a company you can read their press releases, look at their financials, valuation ratios etc. but the best investors need to stay ahead of the game and should try to find new ways to gauge sentiment.

Company specific blogs help investors or potential investors see if people appear to be happy or frustrated with a particular stock. Whether the blogger is a shareholder, employee, CEO or manager, this information can sometimes tell a lot about what direction a stock is going in.

Moreover, investors/traders get to understand the company operations from another angle. They can use this new tool as part of the research/due diligence process.

3/25/2006 8:18 PM  
Blogger DanielXX said...

Wow that's cool. Frankly, I never really felt blogs were anything other than something to boost one's ego through personal publishing. :-)

Thanks, will check out the link on Google.

3/25/2006 8:55 PM  
Anonymous Anonymous said...

Hi Daniel,

More proof blogs are becoming mainstream. My article was in today's edition of the Financial Times.

3/27/2006 5:55 PM  

The internet has changed stock investing forever.

2/09/2014 10:32 AM  

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