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How social media can exacerbate reckless retail trading, according to one behavioral finance pro

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The rush of retail investors to the stock market has been a hot topic on Wall Street.

Individual investors have increasingly taken advantage of trading platforms such as Robinhood during the Covid-19 crisis, with some of their top stock picks outperforming those of hedge fund managers.

Some, like Astoria Portfolio Advisors’ John Davi, ascribe the action to historically low interest rates driving buyers to find new sources of income.

“The Fed has anchored interest rates near 0%, so, it’s kind of forced people out [on] the risk curve,” Davi, his firm’s founder and chief investment officer, said Monday on CNBC’s “ETF Edge.” “I think that’s … a big catalyst to get a lot of people taking their money out of the bank and going into the stock market.”

But many retail traders have taken a liking to penny stocks and plays at risk of bankruptcy, suggesting they have higher risk appetites than they did in past economic slowdowns.

One possible explanation for the phenomenon could be the rise of social media, Dan Egan, managing director of behavioral finance and investing at Betterment, said in the same “ETF Edge” interview.

“We don’t tend to brag about the fact that we lost $15,000 last week or we made a really bad mistake or something went awry,” he said. “We all tend to brag about how easy it is to beat the market, and there is a real sample bias in what most people are going to understand goes into that investing.”

Brokerages are eager to seize on the hype, too, Egan said.

“A lot of places are very happy putting out figures that reinforce the idea [that] this is fun, it’s fast, it’s easy, you should be doing it, too, but there’s some real sample bias there. People can easily get the idea that this is really easy,” he said. 

Beyond that, “there are narratives out there that say, ‘The Fed’s going to come in and buy no matter what. They are not going to let companies actually go bankrupt,'” he said.

In some corners of social media, those narratives are spun into the idea that “you are a fool if you don’t buy the companies that are losing money,” Egan said.

“Amongst sort of novice retail investors, these narratives make you feel like it’s an easy win for you to go in, trade a couple of low-value stocks that have recently fallen, and that you’re guaranteed to make more money and beat the stock market and be able to brag to your friends about it,” he said.

The lesson here is that people must take it upon themselves to research their investments, Egan said.

He recalled when, earlier this year, stock pickers appeared to mistakenly buy shares of Zoom Technologies (which then traded under the ticker ZOOM) instead of Zoom Video Communications (ticker ZM) when the latter made its public market debut.

“There’s a lot of shooting from the hip, a lot of people not really doing a lot of research and understanding even which company is which that contributes to this,” Egan said.

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