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March 15, 2013

New Highs! Stock Promoters, Media Manipulation, and Timing Price Reversals

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New Highs! Stock Promoters, Media Manipulation, and Timing Price Reversals

March 16, 2013, v3, n4

In This Issue

Why Pump-and-Dumps Work

Putting on My Tinfoil Hat

Mining Social Media for Evidence of Insider Trading

Trading Recap

Richard L. Peterson, M.D.
+1 (323) 389-1813 [email protected]

Calm_Gauge

Fearmometer

March 16, 2013

Recent Press:

Dow record makes those not in the market itchy to act.

Eve Troeh. Marketplace Morning Report for Wednesday March 6, 2013.

MarketPsych Preps Sentiment/Chatter-Driven Recommendation Engines. Vicki Chan. Waters Technology. Jan 11, 2013.

Partial List of Past Press.

Pump and Dump

We've had a busy 6 weeks since our last newsletter, and we have many new discoveries to write about. As U.S. equity markets reach new highs, today's newsletter looks at a key factor that both drives poor trading behavior and creates profitable patterns in the markets: price forecasts in the media. First we'll start with a look at a primal, but instructive, form of influence over market prices - the pump-and-dump in social media. Then, by quantifying and backtesting media price forecasts using the Thomson Reuters MarketPsych Indices, we see that investors who follow predictions in both the news and social media lose significant amounts of money. Inversely, those who play against the media do much better.

____

Two days before receiving a subpoena from the SEC, 15 year-old Jonathan Lebed posted the following pitch 200 separate times on Yahoo! Finance stock message boards. He was promoting the stock of a company called Firetector (ticker symbol FTEC):

Subj: THE MOST UNDERVALUED STOCK EVER

Date: 2/03/00 3:43 pm Pacific Standard Time

From: LebedTG1

FTEC is starting to break out! Next week, this thing will EXPLODE. ...

Currently FTEC is trading for just $2 1/2! I am expecting to see FTEC at $20 VERY SOON....

According to Michael Lewis, author of Liar's Poker and Moneyball, Lebed gradually honed the appeal of his promotional messages. Through a trial-and-error process, Lebed learned which aspects of his stock appeals drove investors to buy in spite of any conscious misgivings.

In a 2001 press release, the SEC accused Lebed of touting stocks so that he could make a quick profit on the price jumps he himself had engineered:

On eleven separate occasions between August 23, 1999 (when Lebed was 14 years old) and February 4, 2000, Lebed, of Cedar Grove, New Jersey, engaged in a scheme on the Internet in which he purchased, through brokerage accounts, a large block of a thinly-traded microcap stock. Within hours of making the purchase, Lebed sent numerous false and/or misleading unsolicited e-mail messages, or "spam," primarily to various Yahoo! Finance message boards, touting the stock he had just purchased. Lebed then sold all of these shares, usually within 24 hours, profiting from the increase in price his messages had caused.

Jonathan Lebed settled out of court, reportedly for a minor fine, and kept the bulk of his trading profits. He continued operating as a paid stock promoter through the 2000s at lebed.biz.

When Lebed predicted an explosive gain in a stock price, readers experienced a surge of dopamine. The dopamine increased motivation to act, bolstered confidence, and led investors to discard rational analysis. Interestingly, this is a similar strategy to that employed by the ex-wife (and assorted family members) of late Nigerian President Sani Abacha. You may have received emails allegedly from them offering you a multimillion dollar payout if you agree to hide their billion dollar fortune in your personal bank account (a.k.a. the Nigerian 419 scam). The vast size of the reward blinds gullible respondents to its absurdity.

Why Pump-and-Dumps Work

"The man who reads nothing at all is better educated than the man who reads nothing but newspapers."

~Thomas Jefferson quoted here.

According to a May 2008 New York Times article, Arjun Murti, lead energy equities analyst at Goldman Sachs, foresaw an oil price "'super spike' - a price surge that will soon drive crude oil to $200 a barrel." Mr. Murti is to all accounts an excellent analyst with a great track record, and oil did rise to $147.50 after his prediction, but less than a year later the Oil price was in the $30's.

Sensational forecasts get the media's (and reader's) attention, but they may be destructive to the readers' wealth.

Consider this research by our incredibly talented Chief of Analytics, Changjie Liu. When the news media focuses on positive (or negative) price movement in an industry or commodity, there is likely to be a short-term mean-reversion over a week to a month.

Two studies are described below, one on commodity prices (including oil) and one on ETFs using the Thomson Reuters MarketPsych indices and Thomson Reuters Tick History price data.

The commodities study followed these steps:

We selected the top 10 commodities (Crude Oil, Corn, Gold, etc...) based on their Buzz in the news over the prior month.
Then we ranked each commodity according to its past month's sentiment score. The first sentiment variable tested is MP_PRICEUP (PriceUp), which is a measure of the number of references to the price going up versus down of that asset. The second is MP_MKTFCST (MarketForecast) which captures forecasts of future direction of prices.
The 2 commodities ranked highest on each variable were selected as long positions. The 2 commodities ranked lowest were selected as shorts.
The positions were held one month and then rolled forward from 1998 to mid-2012.
The equity curves from this rotating commodities sentiment arbitrage strategy are displayed below, assuming zero transaction costs.

Note that buying the commodities with the highest positive price chatter and shorting the lowest will lose most of your money.

For ETFs we followed the above steps but used a larger sample of 20 ETFs (vs.10 commodities), went long/short 4 ETFs (vs. 2 commodities), and ran the study from 2007-2012. This equity ETF rotational strategy found similar results to the commodities:

Results Summary: Do the opposite of what you read in the news. The above pattern is also visible for weekly data, but not for yearly.

The news media reports on price increases near the top and price declines near the bottom. If the investing public could be trained to "fade the news," maybe they would be all right, but it's not so simple. Despite the negative outcomes for the investing public, price forecasts - including incorrect ones - drive more news sales and reader/viewership to the news outlets themselves. Consider the success of Jim Cramer's "Mad Money" on CNBC, which is loaded with buy and sell recommendations.

Here are two examples of market forecasts pulled off the web in March 2013 - one about Japanese stocks forecast to continue higher (maybe a pause is in order? Yes, it already started) and one about the recent DJIA highs. (Note, it quotes me about a short-term decline but doesn't mention that I am bullish longer-term).

Putting on My Tinfoil Hat

"We can't quite decide if the world is growing worse, or if the reporters are just working harder."

~The Houghton Line, November 1965

Having been a practicing psychiatrist, I can tell you that some people do in fact wear tin foil hats that they believe will interfere with the functioning of mind-controlling devices. This behavior is strongly correlated with both being off of anti-psychotic medications and being admitted to a psychiatric hospital, and it's generally benign.

Image is from here.

While I don't think of myself as a tin-hat-wearer (who among us does?), based on the above studies, I've got a tin-hat conspiracy theory: the investing media is manipulating our minds, and it is hurting your investing performance.

If you're a contrarian investor, you already knew this. But most of the public doesn't get it. And even if you are contrarian, you will struggle mightily to recognize it when it is most relevant and damaging.

Big tobacco and big food companies also sell us what we want and let us deal with the personal consequences of our misjudgment. According to recent press about the food industry and the design of processed food, foods can be engineered to excite our senses, incite cravings, prevent the feeling of satiety (and thus drive us to eat more). Cheetos are apparently the ultimate example of this. Such engineered foods feel satisfying in the moment, thus driving repeat usage, but are bad for our long term physical and financial health.

We believe our data shows that the news media has learned how to excite these gambling-prone neural circuits, to our detriment as investors.

But it's not only the news media, investment recommendations in social media are just as bad as news'. Social media is a different beast - saavy investors expect an army of Lebed-related promoters to be driving social media schemes. It's not illegal, and it does earn them a steady profit. But what we found is that it's not only a few paid promoters that make bad predictions - just about everyone in investment social media is bad at predicting stock prices.

Mining Social Media for Evidence of Insider Trading

In 2011 a Fortune 100 company approached MarketPsych about a strange pattern in their stock price. Before major news releases, the stock moved significantly in the direction of the news (positive or negative). But after the news was released, the stock barely budged. This firm was concerned that an insider was leaking information about the news to others. Not having telephone logs for their employees or wiretaps on their cell phones, they requested that we scan social media for evidence that traders were aware of company news before the release. When we asked what type of information and when it was being released, we were told "we can't tell you - just look for someone who is really good at predicting our stock price or earnings."

Fortunately, as we noted above, we track forecasts of price and earnings. We looked at the past ten years of social media mentions of the stock of that company: over 2 million. Then we looked how many of those messages contained explicit stock price forecasts: over 14 thousand. Of those 14 thousand, they were split between those with a "StockDown" and those with a "StockUp" forecast. The image below portrays the division of messages:

Then we analyzed the accuracy of the forecasts for the top ten forecasters. None of the most frequent forecasters showed greater than 50% accuracy. On average the top forecasters demonstrated about 45% directional accuracy for the next day. Then we looked at everyone else, and they showed even worse accuracy, with an approximate 40% success rate for both StockUp and StockDown predictions. The average social media stock price forecast is likely to be wrong 60% of the time. See graphic below:

Images and research performed by Aleksander Fafula, PhD

So what is the lesson of all this research?
>> Don't pay attention to forecasts in the media unless you've got a back-tested strategy for trading against them <<

Trading Recap

Going forward, we have a one-week buy on Gold (GLD) due to a spike in pessimism as the price has fallen and global economies have recovered. Looks like a one-week bounce is in order. We also see one-week sells on Herbalife (HLF) and Advanced Micro Devices (AMD) due to investor relief that the worst is over for those companies (the relief is likely premature). (SEE DISCLAIMER BELOW).

Overall we've been bullish on equities, most recently with an explicit call to buy on fiscal cliff-related dips in December in 2013. That advice was borne out with markets up more than 8% since January 1^st. Last year we also demonstrated that our bubbleometer on Apple was hitting highs when it was $630/share and again when it was over $700 (it's now around $430/share).

Last newsletter's one-week buy signal on 8x8 Inc. (EGHT) lost 2.7% by week's end (although it was up over 3% during the week). And our one-week short on Sierra Wireless (SWIR) was also wrong with that stock rising 1% by the week's end.

We are setting up a website with specific long and short-term investment recommendations for currencies, ETF's, and country investments. We will let you know via this newsletter when the site is available for use. Stay tuned...

Housekeeping and Closing

Remember to avoid acting on price predictions in the media, especially those laced with fear. While paid stock promoters and the fake Mrs. Sani Abacha endanger your wealth, their tactics are fairly transparent. The danger for most investors is contagion of excitement from reporters and social media commentators - excitement that drives investors to do exactly the wrong thing at the wrong time.

We love to chat with our readers about their experience with psychology in the markets - we look forward to hearing from you! We especially love interesting stories or your or others experiences.

We will be in Boston next week at the CFA Wealth Management Conference, and we have 2013 speaking engagements in New York, London, Dallas, Orlando, San Francisco, and Boston - we look forward to seeing our friends in those cities! Please contact Derek Sweeney at the

Sweeney Agency to book one of us as speakers for your organization: [email protected], +1-866-727-7555.

In 2012 we launched the Thomson Reuters MarketPsych Indices for monitoring market psychology for 30 currencies, 50 commodities, 120 countries, and 40 equity sectors and industries in social and news media. This data is used by top global hedge funds to improve their investment returns. Please let us know if you'd like to learn more.

Happy Investing!

Richard L. Peterson, M.D. and The MarketPsych Team

Books
Both books named "Top Financial Books of the Year" by Kiplingers.

MarketPsych: How to Manage
Fear and Build Your Investor Identity

Inside the Investor's Brain:
The Power of Mind Over Money (Wiley Trading)

Who We Are

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Optimized to identify value over two+ years of real-time trading.
The Thomson Reuters MarketPsych Data feed includes minutely macro indices tracking reported price action, supply and demand dynamics, media expectations, and other concepts and sentiments from 2 million articles daily for major countries, commodities, currencies, ETFs, and equities (over 20,000).
Contact:
Richard Peterson
+1 (323) 389-1813

[email protected]

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This material is not intended as and does not constitute an offer to sell any securities or a solicitation of any offer to purchase any securities.

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