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Retail is Detail. A well-known phrase that describes what's required to succeed on the high street or in e-commerce.
The basic premise is that each part of a retailer's offering must be correct, right down to the most granular level, if they are to outperform their competition.
I would suggest that this idea is also applicable to Retail Traders, that they need to pay attention to the whole just as much, and perhaps even more than the grocers and merchants do.
Both groups often operate on thin margins which can be quickly wiped out by miscalculations. For example, Target's stock control or the ASOS returns policy.
In this article, we'll look at several pieces of research and commentary that exemplify why it's so hard for retail traders to make money (or more importantly, to keep the money they make).
Let’s start with the rise of social trading and the idea that by combining forces and sharing information, retail traders could get one over on Wall Street...
Lasse Heje Pedersen of hedge fund AQR Capital did some research on this. The full paper can be found here.
Pedersen examines the behaviour and evolution of different types of traders, the social networks they used, and the price action seen in meme stocks in 2021...
Now, social networks are nothing new to investing and trading. They can trace their roots back (at least) to the 17th century. Standage 2006 suggests that:
“The drama of the South Sea Bubble, a fraudulent investment scheme that collapsed in September 1720, ruining thousands of investors, was played out in (London's) coffee houses.”
Pedersen identifies different types of traders, including
- Naive investors
- Longer-term & rational investors (the importance of rationality and critical thinking crops up regularly in the Macrodesiac chats)
Pedersen's investor types reminded me of work 'on human stupidity' by Carlo Cippola at the University of California, Berkeley in 1976.
Cippola identified what he called phenotypes or observable traits in human behaviour. He divided these into a graphic like the one below. 👇
“Stupid people share several identifying traits: they are abundant, they are irrational, and they cause problems for others without apparent benefit to themselves, thereby lowering society’s total well-being.
There are no defences against stupidity, argued the Italian-born professor, who died in 2000. The only way a society can avoid being crushed by the burden of its idiots is if the non-stupid work even harder to offset the losses of their stupid brethren.
Beautifully harsh. For an overview of Cipolla's essay on stupidity see here
Back to Pedersen. In his paper, he notes that the views of fanatics and rational investors come to dominate over time.
The fanatics, perhaps form what is often referred to in our discord as a very vocal minority.
Furthermore, Pedersen draws the (obvious?) conclusion that the relative importance or weighting of these views depends on the following these groups have, within the social networks, and in the wider market through what he calls social network spillovers.
The chart sets out some of the stages in the cycles identified in his research. 👇
A review of Pedersen's paper by Dr Elisabetta Basilico sums up the findings rather nicely.
“The GameStop saga presented many of the elements included in the model: an investment thesis that spreads via a social network while fanatic views escalate, and the contagious investment idea leads to network effects on prices.
“This starts a bubble, and prices rise further as influencers link to the fanatics.”
“In the meantime, sophisticated momentum investors ride the bubble. In contrast, value investors bet against it, causing high trading volume and volatility, but it all dies down faster than the price bubble.”
The lesson? Form your own opinions, don't be reliant on others (to avoid bubble/fanatic mentality) and time your entry and exits based on your own criteria rather than when everyone else heads for the exit.
Earlier in May Larry Swedroe the head of research at Buckingham Financial reviewed a paper by Ryan Chacon, Thibaut Morillon, and Ruixiang Wang, (published in June 2022) that also looked at the phenomenon of social trading.
Specifically Wall Street Bets and its army of Redditors.
The trio examined whether WSB and its followers generated investing alpha.
Their conclusion was that they didn't. Unsurprising perhaps. Furthermore, investing in a portfolio of long and short tips from WSB would not be profitable on a risk-adjusted basis.
The academics also looked at the posts of the top 40 WSB posters by message volume and examined the individual performance of their recommendations.
There was a wide dispersion of results with a range of almost 30% (14.86% to -14.73%).
However, when they calculated the average Cumulative Abnormal Returns or CAR among the group they reached a mean of just 0.25% and a median return of just 0.38%.
In simpler terms
“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.”
The academics concluded that while WSB recommendations induced trading activity (great for brokers and Kenny G)...
“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.”
Larry Swedroe reinforced those findings by drawing a comparison with a social trading ETF writing that:
“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 backtesting 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”
“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.”
Those final comments may seem harsh, but they are probably true for the rank-and-file retail investor or trader.
Part of the Macrodesiac mission is to simplify these puzzles for our audience to the point that they no longer fall into that category.
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