Clients build a carefully curated little echo chamber online.

Despite his best intentions, Johan Bollen, associate professor at the Indiana University School of Informatics and Computing, found himself unwittingly sucked into the social media frenzy that ensued after the recent military coup in Turkey.

Investors — many of whom undoubtedly reacting directly to what they read in their social media networks — almost instantaneously started dumping emerging market currencies. The Turkish lira nosedived to its lowest levels in close to eight years.

What struck Bollen more than anything else in this reaction was his own attitude vis-à-vis the flurry of information and views flying around on Facebook, Twitter and other social media platforms. “I was shocked at how quickly I was swept up by all the alarmist stuff going on online, even though the coup was failing and was easily contained,” he said.

His own behavior, Bollen said, is evidence of how easy it is for people to become emotionally connected to any given event as it unfolds on social media. Investors quickly form opinions that lead to actions that might not necessarily be to their advantage. This “mood contagion” phenomenon is having an increasing impact on the financial behavior of individual investors. The subsequent effect of that behavior on capital markets is of great interest to a growing number of scientists like Bollen.

“Social media really amplifies any event, and even something relatively minor can have a huge impact on the way that it influences people’s behaviors and thinking,” he said. “When people’s emotions are stoked by social media, that reverberates and creates some kind of collective wisdom that may or may not be the best to follow.”

The impact of social media on behavior and capital markets is an ongoing field of study that is gaining importance. The research, as it unfolds, can be of great use to financial advisors — especially those who are using behavioral finance principles to understand their clients and help them make better investment decisions.

Social media is a huge force that will continue to grow, said Jaroslav Bukovina, a doctoral candidate at Mendel University in Brno, Czech Republic, and the author of a recent paper entitled “Social Media and Capital Markets: An Overview.” Advisors constantly strive to get their clients to tune out short-term noise and focus on their longer-term goals, but with so many people following social media and using it as their main source of information, that task is becoming increasingly harder to accomplish, Bukovina said.

Advances in technology will enable more people to get online and trade as individual investors, even if they have a financial advisor, Bukovina said. The growing body of data on how people use social media as a guide to making their financial decisions can, he said, help advisors deal with the power and influence of social media.

Economic Echo Chamber 

Of course, science hasn’t as yet established the extent to which social media shapes investment decisions. Clearly, though, it is a powerful tool that influences behavior and catalyzes the herd phenomenon so many fall prey to, which in turn has strong repercussions for financial markets.

One way advisors can get an edge over the constant and ceaseless information flow that social media creates is to try to get a sense of which social media platforms their clients are on and what groups they follow online. That can be of help in guarding against poor or potentially dangerous investment decisions, Bollen said, and even guiding them toward better ones.

His research has shown that most people’s social media world is a carefully curated universe composed of a network of people they want to follow.

“It seems that people select those who conform to their world view and that is who they follow,” he said. “They follow the views and opinions of that group, and then they tweet and retweet those views and opinions.”

An important part of Bollen’s research focused on the analysis of 10 million tweets posted by 2.7 million users. It revealed associations between tweet sentiments, stock returns and trading volumes. More importantly, though, the research showed that within online communities, there are certain “extraordinary” users that consistently share high-quality data that can lead their followers to make financial decisions that have positive outcomes.

“So as much as the collective wisdom can be off and lead people to bad investment decisions, we do see the emergence sometimes of a collective wisdom that is smart and better than individual assessments of a certain event,” Bollen said.

The existence of investors with “bounded rationality” is an important revelation that social media usage data has revealed, Bukovina said, and they may play a key role in shaping capital market activity.

— Read How Advisors Can Turn Market Volatility Into a Positive on ThinkAdvisor.