Classic investment theory suggests the best returns occur when people trade on information that is not freely available. But two academics from the MIT Media Lab think they have mathematical proof that sharing info with the right people in social networking communities can significantly boost stock trading returns. If they are right, wealth could be spread more evenly in the collaborative economy.
The academics — Dr. Yaniv Altshuler and Professor Alex “Sandy” Pentland — have spent the last three years crunching data on eToro, a global social trading platform that uses real-time features to allow users to follow and copy other people’s trades. During that time eToro has chalked up 50 million trades. The site claims to be the world’s largest online investment network, with more than almost three million users across 190 countries.
eToro, which has raised $33.9 million in venture capital, encourages novices to try their luck by allowing them to see how the “social gurus” in the space trade and then copy them. eToro pays the traders who get followed on a quota basis up to $10,000 per month to encourage them to share information. Like other investing sites it takes a commission on the trades made but does not charge any other fees for its service.
The premise — and the network set-up — intrigued Altshuler, an Israeli serial entrepreneur who is currently a post-doc associate at MIT's Media Lab and Pentland, who directs MIT’s Human Dynamics Laboratory and the MIT Media Lab Entrepreneurship Program and co-leads the World Economic Forum Big Data and Personal Data initiatives. (In 2012 Forbes named Pentland one of the "seven most powerful data scientists in the world," along with Google's founders and the CTO of the United States; he is considered a pioneer in computational social science, organizational engineering, wearable computing like Google Glass, image understanding, and modern biometrics.)
As people engage more with social networking sites, there is always the danger that they become “echo chambers,” i.e., reflect a “group think” mentality that leads people to follow a group consensus rather than critically evaluate information. Other potential pitfalls include making decisions without any guidance from the social network or following “gurus” who provide them with bad information. The challenge on eToro’s and other networks is how to avoid these errors and maximize the “wisdom of the crowd.”
Altshuler has developed a mathematical model for social financial trading that helps guide users to make better decisions by improving the information flow within the networks. This is accomplished by diverting the traders’ attention away from certain links, and drawing their attention to others, changing the dynamics of the network.
Working with the eToro social investment network, Altshuler and Pentland distributed $20 trading coupons to 500 active financial traders on the platform. Matches between traders and recommendations were based on an innovative algorithm designed to optimize information flow within the network. The relatively small number of coupons was enough to move the network away from dangerously high levels of “group think,” and as a consequence, the entire trading community —not just the 500 coupon users — saw a significant increase to their rate of return, says Altshuler.
The increase in return was more than 10% compared with those who traded without guidance from the social network, and 4% higher than those who only followed the highest-performing social gurus.
The study demonstrated how an efficient collaborative trading community can be formed by carefully balancing the complex mixture of ‘trend setters’ and ‘bellwethers’ who govern the behavior of the crowd, says Altshuler, who has a PhD in Computer Science from Israel’s Technion and is considered an expert on collective intelligence and swarm algorithms. “Networks work as a filter that can filter out the noise and amplify the high-quality information,” he says. “It comes down to the topology of the network; the way it is structured influences the way it assimilates information.”
The academics are working with eToro to use the tool they developed to deploy a service that will do “online tuning of the community” to optimize results.
“In the past it was a zero sum game controlled by players like big banks, but now, by combining their knowledge, people at the bottom of the food chain can improve their position, provided that the information network they create is an efficient one. This is what is so great about eToro,” says Altshuler.
He said he and Pentland — who are not being paid by eToro and do not own stakes in the company — plan to soon publish a paper to highlight the mathematical model they are developing to predict how, if people communicate in a certain ways, they will make better or worse decisions.
The tuning tool from MIT should help more people do better on the stock market, which has been the aim of eToro’s network from the beginning.
“Financial markets should be transparent and open to everyone,” says eToro CEO Yoni Assia (pictured on Informilo's home page). “The financial world of today cannot overlook the social revolution, as it stands for the people’s most basic right to get involved in creating their own choices and shaping their own future. Today, with almost three million users and growing fast, we at eToro are confident that social investing is here to stay.”