A Herd Makes Money on Wall Street

Friday, March 25th, 2011

Jonah Lehrer discusses a new study showing how traders who “sync up” via instant-messaging make better trades — and draws a tenuous connection to fish forming schools to deal with predators:

After getting access to the internal files of the hedge fund, they analyzed every IM sent by 66 day traders over an 18-month period. They discovered that these traders sent out an astonishing number of messages, more than two million exchanges over the course of the study, the average trader engaging in 16 IM conversations at a time. [...] After a burst of messages in response to a news event, the traders often acted in sync, converging on the same conclusion and executing a large number of trades at the exact same time. (These IMs typically featured short bits of analysis and did not involve the spread of insider information.) Although they weren’t trying to coordinate their buying and selling, they ended up acting together, just like a school of fish moving as one. This synchronous behavior proved to be an immense advantage. Though typical traders barely beat random chance, those acting at peak moments of sync made money on more than 70% of their stock trades. They also made nearly twice as much money per trade, which explains why traders who frequently “sync up” were the best performers at the firm. (The worst traders, by contrast, were the ones who instant-messaged the least.) “These plugged-in traders have an edge that puts them in a superclass,” Mr. Uzzi says. “What’s interesting is that their edge comes from the crowd, from everyone else around them.” At the moment, it’s unclear how individual investors or financial firms can take advantage of synchronous behavior. One possibility that Mr. Uzzi suggests is to “double-down” on investments that occur when traders are synced, since those are so much more likely to be profitable. “When you see a lot of IM traffic, and then traders within the firm start acting in unison, the odds are that’s going to be a good decision,” he says. “Those are the trades that I’d bet on.”

Or they could simply be moving the market together.

Leave a Reply