New research from the European Securities and Markets Authority (ESMA) has identified a transitory, yet potentially significant, effect on European equity markets.
Social media sentiment: Influence on EU equity prices examined the influence of social media on stock prices. The main takeaway is that social media has an influence on stock excess returns, with positive social media sentiment seemingly correlated with higher returns in the very short-term. But the research did not find any evidence of a link between social media activity and excess returns in the longer-term.
The research, spanning the period from January 2019 to June 2023, analysed the STOXX 600 index, encapsulating a substantial portion of the European stock market.
While information spreading on social media platforms may affect investor trading choices and amplify daily market movements, price overreaction typically does not last more than one day and is only transitory, the study found.
But the findings highlight the risks associated with using social media, and the information, opinions, news and views found on the gaggle of various platforms, to inform trading strategies and decision-making.
“Increasing social media interactions and related sentiment among investors influence the collective investor behaviour with potential effects on financial market dynamics. This comes with notable risks for retail investors, raising investor protection concerns. It may also involve wider market movements with systemic implications, increasing financial stability concerns,’ the report noted.
Joseph Cordahi, product strategy director at NeoXam, told BEST EXECUTION that ESMA’s findings on the impact of social media on stock market returns offer valuable insights into the evolving landscape of investment decision-making.
“If social media continues to shape market sentiments, it’s crucial for institutional investors to exercise caution and diligence in sifting out the golden nuggets of insight from the conjecture. The quality and timeliness of data is paramount to empowering investors to make informed decisions amid the dynamic interplay of social media and financial markets,” Cordahi said.
Previous research has shown that the effect of social media on stock prices is higher than that of conventional media, in particular on a daily basis. Other research has shown that Twitter sentiment contains information for predicting future stock returns. “This predictive power is higher where there is high information asymmetry,” the study noted.
Because social media may unintentionally cause prices to be less efficient in the short term, institutional investors can therefore exploit the behaviour of irrational investors as sentiment-driven noise traders who use social media platforms. “This is concerning from an investor protection perspective and, potentially, for market manipulation.” A noise trader describes traders or investors who make trading decisions without the support of professional advice or advanced fundamental or technical analysis.
While the above concerns have not materialised in the European markets, the researchers point to the GameStop frenzy of 2021 in the US as a warning.
ESMA said its latest research should spur further analysis on the implications of social media interactions on financial markets. “The scope for such an analysis, however, is large and entails several aspects that are crucial to fully understanding these dynamics. This, therefore, requires further and more accurate research that is currently impeded due to the limitation on data availability and accuracy.”
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