“Watching the tape or watching the wheel – what is the difference morally?”
Visualizing History
Stock Market Democratization (1900 – 1928)
From the Archives
The Diffusion of Stock Ownership in the US (1930)
Sunday Reads
SEC Chairman’s Testimony
Gary Gensler, the new Securities and Exchange Commission Chairman, appeared before the House Financial Services Committee this week to discuss a range of critical issues facing modern markets. In today’s post, however, we are going to focus on two particular excerpts from Gensler’s testimony: Gamification & Social Media.
Gensler dedicated a standalone section of his testimony to discussing “Gamification & User Experience”:
“Mobile apps have done a lot to expand access to capital markets, making it easy for investors to sign up, start trading, get wealth management advice, and learn about investing. These apps use a host of features that have come to be familiar in our increasingly online world — features such as gamification, behavioral prompts, predictive analytics, and differential marketing.
There isn’t a settled definition of gamification, but broadly, it refers to the use of game-like features — such as points, rewards, leaderboards, bonuses, and competitions — to increase customer engagement.
Beyond gamification, there are also behavioral prompts that encourage users to engage more with an app, much like push notifications we receive on breaking news stories. Other features, such as social trading or copy trading, allow customers to see what others are buying and selling and make trades influenced by that information…
Many of these features encourage investors to trade more. Some academic studies suggest more active trading or even day trading results in lower returns for the average trader…
In addition, many of our regulations were largely written before these recent technologies and communication practices became prevalent. I think we need to evaluate our rules, and we may find that we need to freshen up our rule set. If we don’t address this now, the investing public — those saving for their futures, retirements, and education — may shoulder a burden later.“
Equally important was Chairman Gensler’s thoughts on social media:
“This winter’s events also highlighted the rapidly changing face of social media and its intersection with our capital markets. Online forums can serve as a real community, expanding access and participation. On Reddit, individuals gather in online communities to discuss a variety of topics anonymously, including investing; the subreddit r/wallstreetbets has about 10 million members. A lot of people follow capital markets through various online communities — not only on Reddit, but also on other social media platforms and within trading apps.
New communications channels have long brought opportunities and challenges for markets. Today’s social media tools have far greater reach, scale, and anonymity than previous technologies. This raises a potential issue: the possibility that wrongdoers will attempt to use these powerful forums to hype certain stocks or manipulate markets.
To be clear, I’m not concerned about regular investors exercising their free speech online. I am more concerned about bad actors potentially taking advantage of influential platforms.
Furthermore, it’s no longer just retail investors or even humans who are following these online conversations, but institutional investors and their algorithms. Developments in machine learning, data analytics, and natural language processing have allowed sophisticated investors to monitor various forms of public communication to see relationships between words and prices.
This practice, called sentiment analysis, has picked up steam in the last couple of years, and it has grown to include online communities. With that comes the risk that nefarious actors may try to send signals to manipulate the market. This is an area for which we will continue to deepen our understanding, resources, and capabilities.”
The Great Game of Speculation
Wow, so much to unpack. While I certainly do not mean to imply that this is not an important issue to address and resolve, it is interesting to note that the concept of financial markets as a “game” stretches back to the very inception of markets itself.
In the first ever behavioral finance book published in 1688 (pictured above), the author refers to investing as a “game” on several occasions. I’ve provided two of these excerpts below:
“This business of mine [investing] is a mysterious affair, and that, even as it was the most fair and noble in all of Europe, so it was also the falsest and most infamous business in the world.
The truth of this paradox becomes comprehensible, when one appreciates that this business has necessarily been converted into a game, and merchants [concerned in it] have become speculators.“
“The Exchange business is comparable to a game. Some of the players behave like princes and combine strength with tenderness and amiability with intelligence, but there are some participants who lose their reputation and others who lack devotion to their business even before the play begins.“
– Confusion de Confusiones (1688)
In 1874 there were hundreds of references to markets as a “game” in financial books at the time:
“It must be so obvious to every reflecting mind, that so dangerous a game as stock Exchange speculation… if it be only partly to satisfy a craving for some sort of excitement, is a very unwholesome pastime.”
Written across many centuries, these quotes illustrate the fact that investing and financial markets have been thought of as a game since time immemorial. The question, therefore, should not be how do we stop markets being “gamified”, but rather how do we ensure that the game is fair, and that all participants know how to play.
I’ll end this section with one of my favorite quotes from an 1864 book on the market as a “game”:
“This fresh phase in the great game of speculation terminated in 1837, the lessons of the past were evidently altogether forgotten…”
Social Media & Herding
Before getting in to today’s incredible articles, I want to focus on a second key section of Chairman Gensler’s written testimony. In particular, I thought that this excerpt was interesting as it highlighted a problem for investors stretching back centuries:
“New communications channels have long brought opportunities and challenges for markets. Today’s social media tools have far greater reach, scale, and anonymity than previous technologies. This raises a potential issue: the possibility that wrongdoers will attempt to use these powerful forums to hype certain stocks or manipulate markets.“
While this seems obvious on its face, the deeper and more fascinating issue underlying this issue is the fact that throughout history investors have not become better-informed about financial markets even when technological innovations equip investors with more information, data and resources to make good decisions. The amount of data and information available on the modern investor’s smartphone is truly mind blowing. Armed with this plethora of information and data, in addition to an increasingly wide set of assets to invest in, one would think that there would be less herding behavior. Why just invest in the same “meme” stocks as everyone else when you have so much insight on thousands of other investments?
Oh, right, human nature.
See, despite technological innovations producing more information and data than ever, no amount of innovation can override our human nature and tendencies to follow the herd. This clip from my history course shows how even back in 1694, when investors had roughly 100 stocks to choose from on the London Stock Exchange, they herded into the 8 most popular stocks covered in a widely-read financial newsletter.
Insights on 1690s IPO / tech bubble.
*100 stocks* available to trade on London's market, but investors herded into the same *8 stocks* listed in a popular 'newsletter' at the time.
Familiar?
Excerpt from @18thc_finance 's fantastic lecture in the Investor Amnesia course. pic.twitter.com/j8J5ddHRbT
— Jamie Catherwood (@InvestorAmnesia) May 4, 2021
The larger problem, however, is when bad actors take advantage of this behavioral bias and launch fraudulent scams. As the article on the NYSE in today’s post discusses, a great example of this comes from John “Jake the Barber” Factor in the 1920s:
“For those involved in the sharepushing game, this sense of confusion amongst investors over which newspapers to trust was certainly something that they sought to exploit for their own advantage. Perhaps the most skilled proponent in this respect was the shadowy figure of Jacob Factor (a.k.a. ‘Jake the Barber’ — brother of the famous cosmetics magnet Max Factor and long-time associate of Arnold Rothstein and the New York mafia), who is estimated to have swindled the British public out of well over £2 million during the 1920s through a series of well-orchestrated sharepushing scams.
Central to Factor’s illicit schemes was a small publishing firm called the Broad Street Press Company (owned by Factor), which published a series of weekly financial newspapers with grandiose-sounding titles such as The Stock Exchange Observer, City News, The Financial Observer, and Finance. Unlike standard financial newspapers, these publications were generally not available to buy in the shops. Instead, free sample copies were distributed by post to specific regions/districts of the country that Factor and his associates felt would be particularly receptive to his message. Those recipients who wanted to receive more copies could then subscribe for three months for a cost of five shillings.”
The article goes on to point out that increased information and choices actually leads to more bad decisions and herding as investors become too overwhelmed by the deluge of information. Essentially, investors find themselves stuck in the paradox of choice.
Alright, after that lengthy intro, let’s dive in!
Strangling Speculation: The Effect of the 1903 Viennese Futures Trading Ban
“How does futures trading affect the volatility of spot prices? This paper uses a unique early-twentieth century setting to test what happens when futures trading no longer exists. In 1903, futures trading in the Viennese grain market was banned. The permanency of this ban makes it ideal for studying the prohibition’s effect on volatility. Prices from Budapest, a market operating under similar conditions but unaffected by the ban, are used as a control. This paper finds increased spot price volatility and lower pricing accuracy because the information-transmission and risk-allocation functions of the futures market were no longer maintained.”
Visualizing History:
“The consequences were to be more severe than expected by contemporaries: the Viennese grain market lost attractiveness at both the local and international level. The socio-political strings pulled to carry through this permanent prohibition of futures trading were strongly linked to populism and a fear of “undue”, uncontrollable speculation. Strangling speculation, however, may have come at too high a cost: the market was abandoned and the supply of grain severely affected.”
A Shackled Revolution? The Bubble Act and Financial Regulation in 18th Century England
The “Free and Open” “People’s Market”: Public Relations at the New York Stock Exchange (1913-1929)
A Nation of Investors or a Procession of Fools?
Referring back again to the SEC Chairman’s congressional appearance this week, Chairman Gensler stated that the SEC would be scrutinizing the relationship between social media and online trading following the wild swings in stocks like GameStop this year.
In general, the market is seemingly moved more by news headlines than ever before. This paper dives into the relationship between media coverage and stock returns on the London Stock Exchange between 1828 – 1870. Was there a difference in returns for stocks that were covered in the news and those that weren’t?
“News media plays an important role in modern financial markets. In this paper, we analyze the role played by the news media in an historical financial market. Using The Times’s coverage of companies listed on the London stock market between 1825 and 1870, we examine the determinants of media coverage in this era and whether media coverage affected returns. Our main finding is that a media effect mainly manifests itself after the mid-1840s and that the introduction of arm’s-length ownership along with markedly increased market participation was the main reason for the emergence of this media effect.”
Visualizing History:
“The main finding of this paper is that media coverage of stocks grows substantially after the emergence of arm’s-length and diffuse ownership in the UK from the mid1840s onwards. We argue that the media were playing an important informational role for the new cadre of middle-class investors which emerged at this time and that the additional information generated by the press increased investor recognition for covered stocks. Consistent with this, after the mid-1840s, we find that companies not covered by the media had higher returns relative to media companies.
In other words, as in modern developed country stock markets, there was a media effect in the nineteenth-century London market, but this only emerged after ownership became arm’s-length and diffuse.“
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