CHAPTER 9

SOCIAL INTERACTION
AND INVESTING

How do social interactions affect

individuals investment
behaviour?

Decision making with regard to investments is

a difficult job
Therefore, the advisory services play a major
role in the investment decision making of
individuals
In recent days, the do-it-yourself attitude of
investors is on the rise as is apparent in the
decrease of the number of full service brokers
The newsletter services are also on the rise
indicating the same

Social interactions and

Investment Behaviour

Some of the social interactions that

affect investment behaviour are

Herding
Speed is of the essence (Not!)
Investment Clubs
Investment Clubs and Social Dynamics

Herding

Other peoples opinion about stocks play a

major role in forming social consensus
As investors start being aware of this consensus,
they adopt a herd behaviour
Chat room postings on websites, watching CNBC,
tracking others portfolio performances are some
of the herd behaviour
In herding, the psychological biases are
magnified
The return or loss on investment is also
abnormal

Speed is of the essence (Not!)

The entry and exit timing plays a crucial

role in making short term profits in the
market
The need for real time market data, real
time news services prove that the timing is
everything in market
This need for speed is crucial in trading and
not in investing
When trading with speed, errors will lead to
huge losses

Investment Clubs

An investment club is a group of family,

friends, or co-workers that have banded
together to pool their money to invest in
stock market
There has been a constant growth in the
number of investment clubs in US
throughout 80s and 90s
These investment clubs are registered
under National Association of Investors
Corp. (NAIC)

Investment Clubs and Social

Dynamics

The meetings serve as a point of interaction

for family and friends
Members share research skills and
knowledge
The clubs investment performance affects
the members personally
Successful clubs require regular reports on
investment performance
The decisions are made on logic and
fundamentals of the company, rather than
speculation, feelings and intuitions

Explain how the market is

affected by the herd behaviour?

Large psychological biases affect market

prices of stocks
Often the over valuation of stocks is
explained by this herd behaviour
Some of the characteristics which affect
market are

Market Mania
Short Term Focus
Faith
Social Validation

Market Mania

Herd behaviour in market leads to

overvaluation of stocks
For Example, by the year 2000, the valuation
of internet based companies was too high for
a rational investor to invest in
Despite high valuations of the stock, investors
kept on investing in such stocks
Market mania causes price bubbles and
sudden decline in stock values
The recovery of such stocks will take a very
long time

Short Term Focus and Faith

Market bubbles encourage short term

trading behaviour in individuals
The fundamentals of the company are
not considered during trading, which
may lead to losses during testing times
Faith in fundamentals is lost during
market bubble
Old valuation methods are discarded and
new valuation methods are adopted

Social Validation

Awareness towards stock market leads

investors to talk about it more in social
occasions
Online discussion groups increases
Stock market bubbles occur only primarily
because of psychological biases and not
because of new technologies or new
valuation methods
Consequently problems get magnified as
well