Do individual investors’ stock recommendations in online communities contain investment value?

Abstract

This paper investigates the investment value of individual investors’ stock recommendations within online communities. We find that aggregated recommendations contain no explicit investment value and that following these recommendations may have a negative impact on investment performance. Our results suggest that recommendations are mostly based on simple heuristics and concentrate on a small number of stocks. When restricting the set of recommendations to those made by the most experienced or successful recommenders, results marginally improve but still preclude profitable investment strategies. Experienced and successful recommenders seem more likely to avoid the most expensive pitfalls rather than actually exhibit superior investment performance.

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Notes

  1. 1.

    Genetic algorithms find an optimized set of parameters for a particular problem by mimicking evolutionary processes. Preliminary solutions are combined and mutated in order to find superior solutions.

  2. 2.

    Recent studies have had to classify data into buy, hold, and sell recommendations.

  3. 3.

    For example, buying and selling stocks with recent outperformance (see also, Barber et al. 2009); concentrating on very few stocks, particularly those that are currently receiving much attention (see also, Barber and Odean 2008).

  4. 4.

    http://www.spekunauten.de.

  5. 5.

    That is, from the closing price of the day before to the closing price of the recommendation date.

  6. 6.

    Approximated with the JP Morgan US Cash 3M or JP Morgan EURO Cash 3M index with respect to the major currency of the relevant market.

  7. 7.

    Market capitalization, common equity, and deferred taxes data for the years 2005 to 2010 are taken from Datastream.

  8. 8.

    Not tabularized.

  9. 9.

    Referred to estimated round-trip transaction costs of \(1.3~\%\) for institutions (Barber et al. 2001) and commissions per trade of around \(1.5~\%\) for individual investors (Barber and Odean 2000). Other approaches considering flat fees and applicable duties (Siganos 2009) result in similar ranges for reasonable trades of individual investors.

  10. 10.

    Abnormal returns are significant after the recommendation date for all days in FF3M and C4M and also in CAPM with exception of the first 2 days.

  11. 11.

    Results for CAPM and FF3M are consistent.

  12. 12.

    We exclude the first recommendation, as we suppose it to be a technical trial for a number of users.

  13. 13.

    Reducing the timespan after the recommendation date to 10 days and analyzing the performance of buy and sell recommendations separately yielded very similar abnormal returns.

  14. 14.

    Less than 150 related recommendations.

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Acknowledgments

We are grateful to an anonymous referee for valuable comments on our drafts and to Markus Schmid, the editor. We thank Cetin-Behzet Cengiz, Christian Wegener, Sarah Schiffer, and Philipp von Thunen for their comments on earlier versions of this manuscript.

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Correspondence to Philipp Stephan.

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Stephan, P., von Nitzsch, R. Do individual investors’ stock recommendations in online communities contain investment value?. Financ Mark Portf Manag 27, 149–186 (2013). https://doi.org/10.1007/s11408-013-0208-7

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Keywords

  • Individual investors
  • Online communities
  • Stock recommendations
  • Investment value
  • Event study
  • Abnormal returns

JEL Classification

  • D12
  • G11
  • G14