The wisdom of crowds: Using social networks to make investment decisions
Social networks are a rich source of information about investing — but the crowd isn’t always right. Find out how to leverage crowd wisdom in this expert guest post by veteran investor Brendan Walsh.
10 min read
I've been an investor and trader for the past twenty years (if you're wondering what the difference is, check outthis article). During that time, I've had the privilege of helping and coaching others on their investment journeys. One of the most common questions I get asked is: "How do you come up with investment ideas?" Or: "How do you make investment decisions?" My process is pretty complex. However, at its core lies something simple: ideas, debate, discussion with peers, and being open to being wrong (a lot).While not everyone can access a team of analysts or experienced peers, the internet offers something just as valuable — a vast pool of collective knowledge and opinions through social communities on platforms like X (Twitter), Instagram, TikTok, Discord, and Slack. These platforms have a unique advantage: the wisdom of crowds.However, the crowd isn’t always right, so filtering out the noise — and understanding where the herd is leading you — is crucial. This article will guide you through leveraging socialinvesting while making informed decisions — and it'll hopefully prevent you from following the proverbial lemmings over a cliff.
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The power of social networks in investment decisions
Investing thrives on exchanging ideas. These ideas become stories, and the stories become trades.Social networks are also driven by themes and stories, so it's not a surprise they have become powerful tools for investing. These platforms can connect you with a diverse community of investors, offering insights that can significantly influence your decisions, but not always for the better.
How social networks shape investment strategies
Platforms like X, Instagram, TikTok, Reddit, and Discord have evolved into rich sources of information for investors. These networks are filled with people sharing insights, debating strategies, and discussing market trends. Communities like "FinTwit" on X and Reddit's r/WallStreetBets have shown how influential these spaces can be in shaping decisions and driving markets. The term “the wisdom of crowds” is often used to describe this.
Understanding the wisdom of crowds
The wisdom of crowds phenomenon occurs when the collective judgment of a group often leads to surprisingly accurate results. A classic example is the "guess the jelly beans in a jar" experiment, where individual guesses vary widely, but the average of all guesses is remarkably close to the actual number. This illustrates how diverse perspectives, when aggregated, can produce valuable insights.
The double-edged sword of social networks
Interestingly, one of the earliest books on the topic of crowd psychology actually focuses on the negative aspects. Charles Mackay's Extraordinary Popular Delusions and the Madness of Crowds, published in 1841, gives numerous examples of when the crowd was wrong and created a bubble, like the South Sea Company bubble of 1711–1720 and the Dutch tulip mania of the early 1600s.
A more recent example is the GameStop saga in early 2021, which shows how social networks can intentionally amplify narratives, creating market movements that are detached from fundamentals. Retail investors on Reddit's r/WallStreetBets drove the GameStop stock price to extreme levels, loosely based on a David vs. Goliath narrative, as several hedge funds were short the stock. This coordinated action of the crowd moved not just Gamestop (GME) but also other similar shares, leading to what was termed the “Meme Stock rally.”
These recent and historic examples highlight the dual-edged nature of social networks: They can both uncover valuable insights and create speculative bubbles.
Communities vs. influencers: Understanding the difference
We can't talk about social networks without mentioning communities or influencers, and it's important to distinguish between the two.
Communities like Motley Fool, FinTwit, or r/WallStreetBets foster collective wisdom through shared goals, where ideas are debated, refined, and challenged, often leading to more robust investment insights.
Influencers, on the other hand, can be a one-person show who may or may not have wisdom to share.
The role of communities
Communities are driven by shared investment goals, encouraging collaboration and the exchange of diverse perspectives. This collective effort can lead to deeper insights and more balanced investment strategies. Of course, in any community, there are competing factions and strongly held opinions. The idea of one big happy family helping each other is naïve, but ultimately, the crowd has shared goals.
The influence of influencers
Influencers, however, operate differently. They build platforms centered around their personal voice to grow their audience. While some provide valuable insights, their primary motivation can be brand growth, which may lead to sensationalism or attention-grabbing rather than sound advice.This doesn't mean all influencers should be dismissed, but caution is necessary. Always consider their motivations — are they offering well-researched insights, or seeking likes and shares? The loudest voice isn't always the most reliable. Remember, their ultimate goal is the same as yours: to generate wealth. However, the path they take to get there is growing their audience, not successful investing, regardless of what they say on TikTok.
Finding and engaging with the right communities
To effectively leverage social networks, start by identifying communities that align with your investment goals and risk tolerance. If you're focused on long-term growth and value investing, communities like The Motley Fool, FinTwit, or Discord channels dedicated to fundamental analysis might be ideal. For those drawn to high-risk, high-reward strategies, forums like r/WallStreetBets may resonate — but remember to approach cautiously.
Evaluating community tone and dynamics
Evaluate the community's tone. Supportive groups that prioritize education and constructive criticism are more beneficial than those driven by hype and speculation. A quick scan of responses to questions asked by beginners should help you gauge the tone. Patience and a willingness to share and explain are good indicators. The red flags should be obvious.
Active participation for better decisions
Active participation in the right communities is critical to reaping the benefits of social networks. You will get more out of a discussion if you engage by asking questions, sharing thoughts, and debating, which will enhance your decision-making process. Remember the adage that strong views are weakly held — you should always try to have a clear view. Don't sit on the fence. It's uncomfortable, for a start, so be prepared to pivot your view if you learn something new. Dogma is the enemy of intelligent investing.
Navigating the noise
While diverse perspectives can lead to better decisions, they can also create noise. Prioritize well-reasoned explanations over bold, unsupported predictions. Seeking varied viewpoints and challenging your biases will help you avoid tunnel vision and make more balanced decisions.
It's also essential to understand the psychological and behavioral dynamics at play. Thinkers like George Soros and Daniel Kahneman have shown how narratives and cognitive biases can influence market behavior, underscoring the need for a critical approach when engaging with crowd wisdom. Once you've found your crowd, you need to understand its nature and drivers.
The dos and don'ts of using crowd wisdom in investing
Crowd wisdom can be powerful, but it's important to understand its limitations. Investors often make decisions based on compelling narratives rather than pure data. We make sense of our world using mental models — or stories, if you like. These can be based on data and research or on our own internal biases or behavioral defaults, so it's essential to understand how to tell the difference.
Recognizing the limits of crowd wisdom
Crowds can be swayed by stories that aren't always grounded in reality. Markets often move on these narratives, whether they involve technological breakthroughs or economic fears, sometimes detached from fundamentals. For instance, the rise and fall of meme stocks like GameStop wasn't driven by traditional financial metrics but by a narrative of small investors taking on Wall Street. This story led to a buying frenzy that pushed prices far beyond what analysis would justify.
The tail wagging the dog
George Soros's theory of reflexivity explains this phenomenon well. Soros argues that investors' perceptions can create a feedback loop where their beliefs drive market realities, reinforcing those beliefs. Recognizing when market narratives override fundamentals is crucial, as these can lead to bubbles and crashes when the story unravels.
Balancing crowd wisdom with personal analysis
While crowd wisdom can provide valuable insights, balancing it with your research is essential. Narratives can drive markets but can also be misleading if not critically assessed. Daniel Kahneman's insights on cognitive biases, like confirmation bias and overconfidence, remind us that these biases can skew judgment, especially in echo chambers. To avoid this, critically assess whether aninvestment idea is supported by solid evidence or a compelling narrative. If you can't find the evidence to back up the story, then maybe it's simply a story. However, that doesn't mean you discard it completely. It can be very profitable to be part of a bubble, as long as you're not the last one out.
What about copy trading?
While copy trading deserves a standalone discussion, it's worth mentioning here. Unlike the wisdom of crowds, copy trading involves replicating the trades of a single, experienced trader. Platforms like eToro and RoboForex allow you to follow top-performing traders. Still, this approach relies on one person's judgment rather than a community's collective insights. This can be risky — if the trader makes a poor decision, you're fully exposed to their losses. Although they have a large following, that could be due to a lucky trade (or worse). There's a paradox here: Copy trading is presented as a way for people to invest who don't know enough to trade for themselves. But if you don't know enough to trade, how can you assess the skill of the person you’re copying?
Using copy trading as a learning tool
While it has drawbacks, copy trading can be helpful if approached as a learning tool rather than a primary investment method. Investing a small, negligible amount allows you to gain visibility into a successful trader's strategy without taking on significant risk. This way, you can observe their decision-making process and leverage the crowd's confidence in this trader to inform your analysis. If they fail, there's minimal harm, but if they succeed, they could be a valuable source of inspiration.
Making your own investment decisions
Harnessing the wisdom of crowds can be a powerful tool in investing. Social networks and online communities, like Reddit's r/WallStreetBets and platforms like eToro, give you access to diverse perspectives, helping you uncover opportunities you might not find on your own.However, crowd wisdom can be a double-edged sword. Narratives often drive market behavior, leading to bubbles or crashes when these stories unravel. George Soros' theory of reflexivity shows how investor perceptions can shape market realities. At the same time, Daniel Kahneman's work on cognitive biases reminds us that mental shortcuts like confirmation bias and overconfidence can cloud our judgment. Just because a story is convincing doesn't mean it's right.The key to successful investing is making informed, independent decisions. While community insights can guide you, it's essential to critically assess whether an investment aligns with your financial goals, risk tolerance, and long-term strategy. Avoid herd mentality by sticking to a disciplined plan and ensuring your decisions are based on sound analysis, not just popular sentiment. Moving with the herd is okay as long as you can change direction when you see the cliff ahead.The crowd can inspire you or challenge your view, and it can also help you understand or explain what is happening in markets. However, the final responsibility lies with you. Use the wisdom of crowds as input, but don't let it be the sole judge of your decisions. By balancing the crowd's wisdom with careful analysis and a disciplined approach, you'll be well-equipped to make investment decisions that help you achieve your objectives.
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