How confirmation bias hurts your wallet

13 Jan 2023 | Confirmation bias

Some forms of confirmation bias occur when there’s little quantifiable at stake. If Republicans watch Fox News and Democrats are glued to MSNBC, their knowledge of the world will be less rich, but they don’t suffer any tangible loss. You’d hope that, if there’s money on the table, people might bite the bullet and overcome their biases.

A study by finance professors Tony Cookson, Joey Engelberg, and William Mullins shows that this isn’t the case. They took 400,000 users of StockTwits, a social network where investors post their own views on a stock and read others’ opinions. Not only can StockTwits users choose who to follow, like any social network, but also posts are marked as either bullish (positive) or bearish (negative) — so you can quickly decide whether to read a post before you’ve even peeked at the contents.

The researchers found that StockTwits users live in echo chambers — they’re far more likely to follow someone who shares the same view. Let’s say Angus and Céline are both Tesla bulls, and Bruno is a Tesla bear. The data shows that Angus is five times more likely than Bruno to follow Céline. As a result, over a 50-day period, Angus sees 62 more positive messages and 24 fewer negative messages about Tesla than Bruno. His newsfeed is highly skewed.

But does this really matter? What if Angus is just a Tesla fanboy — he goes on StockTwits because he likes reading good things about Tesla, but doesn’t actually invest? Surely, if you’re staking your own money, you’ll check if there are any flaws — just like, even if you’ve found your dream home, you’ll survey it before buying. Actually, it’s the opposite. Users whose posts mention that they made a trade (such as “$TSLA. Just added 100 shares”) are two to three times more likely than everyone else to follow someone of the same opinion.

These echo chambers mean that StockTwits tips are bad advice. If you buy after a positive tip or sell after a negative one, you’d lose 1.9% over the next five days. It’s even worse if the tip was from a user in the narrowest echo chamber of all — someone who only saw one side of the story. If Delphine touted Apple, and she’d only seen positive posts about Apple over the last 30 days, following her advice would cause you to suffer an even bigger loss of 2.3%. But if Eduardo hyped up Amazon, and he’d seen an equal number of positive and negative tips over the last month, you’d only lose 0.9% by listening to him.

Staying in the comfort of our echo chamber might help our feelings, but it hurts our wallet.

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