Critically evaluate the contribution of social media to investor sentiment and stock prices. Introduction The rise of social media has created a powerful new platform for users to create and share content/information or to participate in social networking. According to Deloitte (2007), 82% of internet customers in the U.S. are directly influenced by peer reviews. Cogent Research 2008 reported that nearly one in four adults in the U.S. directly rely on investment advice transmitted vis social media and 90% of high net worth investor groups use social media to inform personal investment decisions Investors access the internet to obtain information and increasingly through social media create online communities to educate each other and share opinions and investment ideas in relation to their investments in stocks, funds and portfolios. People generally believe that more information improves their ability and lead to greater accuracy in decision making. However the illusion of knowledge could lead to overconfidence. Today, companies use social media not only as a marketing tool but also to disseminate corporate information and results to help reduce information asymmetry. Companies through social media targeting a wider audience, can increase brand awareness and influence buying decisions. Given there is illusion of knowledge, investors must remember that not all information access through the internet and social media are true and give the complete picture of a situation or companies. Most social media are an information-pushing platform and relies on comments or opinions from others e.g. Twitter is a micro-blogging and personal-message sharing service. The opinions or commentaries do affect investors way of thinking irrespective whether is it positive or adverse information including “managed” tweets from companies. Different people may have a different reaction to the additional knowledge. Impact on investors sentimentRecently, Hennes & Mauritz (H&M) British’s website used the image of a black child to model a sweatshirt using the phrase “coolest monkey in the jungle.” American percussionist Questlove was among those to object on Instagram where he has over 1 million followers) (Thomas 2008).Figure shows the drop in H’s share price caused by the backlash against the company due to the controversy.Social media users erupted in outrage at H&M for what they deemed to be a racist and inconsiderate action. The drop in H&M’s share price show investors reacted immediately either sell their existing stocks or for potential investors not to invest at all, as they do not want to be associated with a company for inappropriate “behaviour”. The case highlights the power and popularity of social media, whereby the shared information spread very quickly and this had an impact on investors and potential investors sentiment. Contribution of social media to investor sentiment and stock prices Tumarkin and Whitelaw examined postings, abnormal returns and trading for the period 1999 to 2000, and found positive postings increase trading volume but not returns. They concluded that this was the result of illusion of control, where investors feel that once they were making their own investment decisions and placing the trades themselves, they had a much greater chance of success. This lead to investors overconfidence and a tendency to trade excessively ignoring the risks before making an investment. In particular, positive early outcomes and active participation increases familiarity which, in turn makes investors feel in control. With familiarity, investors allow their current knowledge of a thing or situation to influence their decisions. However, n investing, there is difference between a good company, or one with which investors are familiar, and a good investment. To examine peer opinions, Chen, De Hu & Byoung-Hyoun investigated opinion articles on Seeking Alpha1 (“SA”) website between 2005-2012 and conducted textual analysis of the impact of user-generated information on stock returns. They focused on the proportion of negative words and comments and found both negatively predict stock returns over three months. Chen et al interpreted that the opinions in SA contained value-relevant information not yet included in the stock prices or that investors had reacted to false information. However, they rejected the latter arguing that access to social media is free and unregulated, thus this should not move stock prices. Since the opinions on SA strongly predict future stock returns and earnings, this implies that peer-based advice performs a useful function in financial markets. In a study by Yu, Duan & Cao, they found blog sentiment has a positive impact and forum sentiment a negative impact on stock return, and positive blog and negative forum posts have a strong positive and negative impact on stock return respectively. The results provide insights into stock returns but no evidence of causation. Ranco, Aleksovski, Caldrelli, Grcar & Mozetic investigated the relation between price/market data (publicly available) and Twitter data (1.5 million tweets along with their sentiments) on 30 DJIA stocks over a fifteen month period (2013-2014). The sentiment tweets were categorised based on three values: negative, neutral and positive. Ranco et al noted there was low Pearson correlation and minimal evidence of Granger causality in terms of polarity for the entire period. The low correlation means only days with a low number of tweets affect the measure. Only three out of the 30 companies passed the Granger test and this suggested that the polarity variable is not useful for predicting the price return. The number of tweets for a company Granger-caused the absolute price return for a third of the companies, which indicated that the amount of attention on Twitter is useful for predicting the price volatility. They also conducted the event study which analysed the abnormal price return2 observed during external events to assess the event’s impact. They noted that during the high Twitter volume periods, there was a significant relationship between Twitter sentiment and stock returns (Ranco et al. 2015). For example, the price return of a stock abnormally jumps in the direction of the earnings during quarterly earnings announcements. In addition, the average cumulative abnormal returns for the events showed abnormally increasing after the positive peaks and decreasing after the negative peaks thus suggests that tweets do indeed convey information relevant for stock returns. The above shows significant evidence of dependence between stock price returns and Twitter sentiment in tweets about the 30 companies. In addition, stock prices are also affected from unsophisticated investors. They may rely on opinions of more sophisticated investors to make their trade. This is not a hard task as the availability of information and opinions and articles online have increased significantly after 2008. Perhaps the reason we see no change in price volatility is because after a unsophisticated investor, who is likely to be risk averse, reads about a product recall or a monthly sales announcement on Twitter, may go to other sources to corroborate or find out more based on what they read. After they read news articles from WSJ or other news sources, their interpretation of that event may converge to what the market believes overall. Hence, they trade in the same direction (or, the distribution of the direction of their trade is the same as sophisticated investors). Conclusion Social networks has not only facilitated the rapid transfer of information but also massively increased the amount of information available to investors. However the volume of information and the add on opinions and comments from others means it is problematic for investors to differentiate between informed and uninformed advice. Increasingly investors using social media should watch out for dubious or fake news to avoid making the wrong decisions which may mean suffering losses for their investments. As seen in the H&M case, comments on an advertisement could through social media can promote and exacerbate collective behaviour. The drop in share price show and reflect investors sentiment toward H&M at the time. The study by there user-generated content is increasingly important in investors buying decisions and there appears to be an impact of user-generated information in stock returns. Despite an increase in fake news and the issue of trust in social media, the percentage check for % of investors who use social media to make investment decisions show the power of social media. Regulators too are monitoring the impact of social media because in the event of a financial contagion or crisis, herding among investors and the collective behaviour of investors may lead to panic and affect the financial system. Although most investors would rely on a variety of resources for investment information, the various studies show social media and social interactions do affect the behaviour of investors. Overconfidence and the illusion of knowledge can lead investors to take risks and make choices that would otherwise seem irrational. As such it is important for investors using social media to exercise discretion when reading the information.