A series of events has led to significantly increased interest in stock and options trading by retail investors:
The arrival of investing platforms (such as Robinhood) with zero trading commissions and no account minimums.
The COVID-19 pandemic, causing many workers to largely remain at home for most of 2020, leading to lower consumer spending and more time to pursue alternative ventures.
The largest ever monetary and fiscal stimulus packages, leading to a significant increase in the amount of cash in retail investors’ hands.
The actions of retail investors gained increased attention when they began to band together through the use of online social platforms and executed strategies like short and gamma squeezes. Specifically, the actions of investors on the subreddit thread (user-created areas of interest where participants on the Reddit website discuss stock and options trading) “WallStreetBets” (WSB) have had a material impact on certain stocks such as GameStop and AMC Theatres. Their success in executing short squeezes raised the question of whether following WSB strategies was profitable.
To answer that question, Ryan Chacon, Thibaut Morillon, and Ruixiang Wang, authors of the study “Will the Reddit Rebellion Take You to the Moon? Evidence from WallStreetBets” published in the March 2023 issue of Financial Markets and Portfolio Management, investigated whether a trading strategy that follows the WSB subreddit could consistently produce alpha. Their approach was to examine how opinions on a given forum can predict individual stock prices—whether a simple and easily implementable trading strategy following WSB could produce alpha. Using textual analysis from WSB submissions over the period 2012 through the first quarter of 2021 when the GameStop short squeeze occurred, they formed a daily rebalancing long-short portfolio that went long “buy” suggestions and short “sell” suggestions, where the suggested stocks could be held for one day, two days, three days, one week, one month, or one year. Their final sample included 221,255 recommendations, 192,550 buy, and 28,708 sell recommendations.
Here is a summary of their key findings:
Investors track and trade on WSB submission information—they believe the information is valuable.
Consistent with the group seeking out short-squeeze opportunities, the typical short interest as a percent of float for buy recommendations was 9% compared to just 3% for the S&P 500.
The WSB community focuses on small growth firms (the average market-to-book ratio was 24.1 for buy recommendations, 2.7 for sell recommendations, and 3.9 for the S&P 500) with high short interest for buys, and somewhat larger value firms with high short interest for sells—“Redditors” seek high-risk, high-reward opportunities.
Redditors also tend to target firms that invest heavily (they load negatively on the investment [CMA] factor), and momentum tends to be positive and significant in the long portfolios as well.
Across all holding periods, the long-minus-short portfolio failed to produce alpha that was distinguishable from zero. In addition, the long portfolio across every holding period was negative, inconsistent with achieving good performance.
Their findings were robust to various tests, including whether the strategy was bullish (when investor sentiment, as measured by the put-call ratio, was high) or bearish (when investor sentiment was low), and weighting the buys and sells by the number of recommendations.
The pre-2021 results were very similar to those of the full sample regarding alphas and many of the factor loadings, alleviating the concern that the results were driven only by the recent GameStop and other meme stock trading activities.
Reddit Strategy Performance
The results are hypothetical results and are NOT an indicator of future results and do NOT represent returns that any investor actually attained. Indexes are unmanaged and do not reflect management or trading fees, and one cannot invest directly in an index.
Recognizing that there is likely heterogeneity of skill across posters, they identified the top 40 (1.6% of the posters) by submission volume and examined their performance. Using a two-day trading window following the buy or sell submission, and benchmarking returns against the Fama-French five-factor model (market, size, value, investment, and profitability) plus momentum, they found a wide range of performance across the top 40, ranging from an average of 14.86% long-short cumulative abnormal returns (CAR) to a -14.73% long-short CAR.
The average long-short CAR for the top 40 posters was 0.25%, and the median was -0.38% (more top posters had negative alphas than positive ones), both very close to 0—the most frequent posters were no more likely to generate alpha on average.
Their findings led Chacon, Morillon, and Wang to conclude that while WSB recommendations induced trading activity, there was no evidence that WSB recommendations produced alpha: “In no cases were the buy recommendations as a group fruitful and in very few cases were the sell recommendations useful. As the viewership and contribution to this public thread have grown, alpha is equally elusive.”
Their findings are consistent with the results of the VanEck Vectors Social Sentiment ETF (BUZZ), which tracks the 75 large-cap U.S. stocks with the most bullish perception from social media and other alternative datasets. Using the backtest tool at Portfolio Visualizer, from April 2021-February 2023, BUZZ returned -24.1%, underperforming the return of Vanguard’s 500 ETF (VOO) by 25.4 percentage points.
Chacon, Morillon, and Wang’s findings contribute to a large body of literature that demonstrates that retail investors, on average, are naive, subject to many biases that result in adverse outcomes while the platforms they trade on prosper. The findings hopefully serve as helpful information to the droves of retail investors searching the internet for trading advice. The historical evidence on efforts of individual investors to generate alpha clearly shows that while it’s not impossible to generate alpha consistently, the odds of doing so are so poor it’s not prudent to try. If you look in the mirror and see Warren Buffett, go ahead and try to pick stocks that will outperform (although even he has not been able to outperform for the past 15 years; Berkshire Hathaway Inc. Class A underperformed the S&P 500 from 2008 to 2022). But unless you live in Lake Wobegon, where everyone has Buffett-like abilities, you will not likely see the Oracle of Omaha in the mirror. For those who don’t, the winning strategy is to build a globally diversified portfolio that reflects your unique ability, willingness, and need to take risk and stay the course, rebalancing and tax managing as events dictate.
Larry Swedroe is head of financial and economic research for Buckingham Wealth Partners.
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As Chief Research Officer for Buckingham Strategic Wealth and Buckingham Strategic Partners, Larry Swedroe spends his time, talent and energy educating investors on the benefits of evidence-based investing with enthusiasm few can match. Larry was among the first authors to publish a book that explained the science of investing in layman’s terms, “The Only Guide to a Winning Investment Strategy You’ll Ever Need.” He has since authored seven more books: “What Wall Street Doesn’t Want You to Know” (2001), “Rational Investing in Irrational Times” (2002), “The Successful Investor Today” (2003), “Wise Investing Made Simple” (2007), “Wise Investing Made Simpler” (2010), “The Quest for Alpha” (2011) and “Think, Act, and Invest Like Warren Buffett” (2012). He has also co-authored eight books about investing. His latest work, “Your Complete Guide to a Successful and Secure Retirement was co-authored with Kevin Grogan and published in January 2019. In his role as chief research officer and as a member of Buckingham’s Investment Policy Committee, Larry, who joined the firm in 1996, regularly reviews the findings published in dozens of peer-reviewed financial journals, evaluates the outcomes and uses the result to inform the organization’s formal investment strategy recommendations. He has had his own articles published in the Journal of Accountancy, Journal of Investing, AAII Journal, Personal Financial Planning Monthly, Journal of Indexing, and The Journal of Portfolio Management. Larry’s dedication to helping others has made him a sought-after national speaker. He has made appearances on national television shows airing on NBC, CNBC, CNN, and Bloomberg Personal Finance. Larry is a prolific writer and contributes regularly to multiple outlets, including Advisor Perspective, Evidence Based Investing, and Alpha Architect. Before joining Buckingham Wealth Partners, Larry was vice chairman of Prudential Home Mortgage. He has held positions at Citicorp as senior vice president and regional treasurer, responsible for treasury, foreign exchange and investment banking activities, including risk management strategies. Larry holds an MBA in finance and investment from New York University and a bachelor’s degree in finance from Baruch College in New York.
Performance figures contained herein are hypothetical, unaudited and prepared by Alpha Architect, LLC; hypothetical results are intended for illustrative purposes only. Past performance is not indicative of future results, which may vary. There is a risk of substantial loss associated with trading stocks, commodities, futures, options and other financial instruments. Full disclosures here.