The recent hacking of the Associated Press's Twitter account showed how information dispersed on social media, albeit false reports of an explosion at The White House, can rattle the stock market. Just last month, the Securities and Exchange Commission (SEC) issued a ruling allowing companies to  disclose key financial information via Facebook and Twitter. Both events underline the growing importance of digital platforms to the financial industry.

Ying Zhang, Ph.D., assistant professor of Finance at Fairfield University's Dolan School of Business , explains below how social media effects financial markets. He has written such published papers as, 'Do Internet stock message boards influence trading?' and 'Online-talk, Does it matter?' He researches investments, asset pricing, behavioral finance, and portfolio management.

"Unarguably, social media is playing an important role in modern life. Needless to say, the Internet has changed the way that we invest, trade and acquire information. In recent years, there has been an explosion of electronic trading that is likely to continue. Rapid growth in stock message boards, chat rooms (private or public), Twitter, Facebook, Google Finance, and other electronic means for investors to share market information makes clear the ever-increasing interest in electronic security trading. In addition to an increasing number of social media channels, growth in the number of participations in these sites has exploded. Meanwhile, the Securities and Exchange Commission (SEC), the Federal Trade Commission (FTC), and the Commodity Futures Trading Commission (CFTC) are especially interested in tracking the activities on these social media sites in order to protect investors' interests.

How exactly does social media impact investors? The answer is at least threefold. First, public companies are now allowed to use social media sites, such as Twitter and Facebook, to disclose material corporate information in compliance with Regulation Fair Disclosure (Reg FD) as long as investors have been told where to find it. Unlike finding news on company websites, investors now can easily receive the latest key corporate news on their individual Twitter or Facebook accounts. Second, social media is a good venue for investors to learn other peoples' opinions about securities and the market. Yahoo! Finance, RagingBull, MotleyFool, TheLion, Google Finance, Twitter, and Faceboook are among the popular social media channels allowing investors to share their sentiment (e.g. buy, hold, and sell) and comments. Third, institutional investors, such as hedge funds and large banks, are conducting high frequency trading which is based on zillions of messages from social media sites. Many high-frequency trading algorithms are programmed to make trades based on aggregated and quantified news (e.g. good news=1, neutral news=0, bad news=-1) within milliseconds. Voluminous studies have found that for one, social media conveys valuable information to investors and increases market efficiency, and secondly, consensus on social media sites explain and predict financial market activity.

However, there are disadvantages: there are numerous cases related to online securities fraud. For instance, in September 2000, the SEC alleged that a 15-year-old individual used Internet stock message boards to talk up, or manipulate, stock prices and then unloaded his positions in a classic "pump-and-dump" operation. In 2007, in a lawsuit trying to block the Whole Foods grocery chain from acquiring Wild Oats Markets, the FTC alleged that John Mackey, the CEO of Whole Foods, made anonymous attacks on Wild Oats Markets on the Internet message boards in order to push down its price so that Whole Foods could acquire it at a lower price. On the other hand, high frequency trading increases market volatility and probability of market crash. We have just seen a fake White House bomb report on Twitter caused brief stock market panic possibly due to program trading - collectively, more pros than cons. Social media will continue having profound influences on financial markets."

For more on Dr. Zhang's research, visit http://www.fairfield.edu/academic/profile.html?id=986 .

Posted On: 05-13-2013 11:05 AM

Volume: 45 Number: 285