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You have seen it on YouTube, TikTok, Reddit, or perhaps a post on your social media feed that has popped up about the latest trade or trading strategies that will "beat the market," this will make you "rich immediately" or with the recent trends "this cryptocurrency is going to the moon."
Have you ever thought to ask yourself: What is in it for the content creator behind the video/post? Are they providing education or using this platform as a way to gain much more?
Videos or posts that claim to have specific trade or trading strategies but disclaim that they are not financial advisors as these strategies are speculation or for information purposes. A disclaimer within the video or post, if any, is often overlooked: "This is not financial advice. Please consult your financial advisor to associate the risks involved," as it is somewhere buried in the video description or stated by the content creator somewhere in the video. Some may not even have such a disclaimer. The small disclaimer is a way for them to cover themselves if a strategy goes horrendously wrong and a user comes back to them and tells them they will sue them.
Ironically, everyone overlooks any disclaimers and will still try out these strategies because human nature is to try to get the same success as someone else. Although there are times when the strategy works, especially if it is in the beginning stages of momentum, there are times when they do not. Content creators are more prone to post their accomplishments, but some post their failures. A viewer is likelier to click on a creator's success than a failure.
Misinformed Creators
Social posts are beginning to be used as entertainment to gain more popularity. In a Bloomberg article, "People are sort of optimizing their videos for entertainment. They are not necessarily as diligent about fact-checking information." This disinformation leads to potential investors following strategies or ideas that may lead them to failure.
Consider the following example of a content creator who has deleted this Twitter post - I was lucky to screenshot that makes content about their investment trades.
A word of caution: Options trading involves huge amounts of risk and may exacerbate your losses, and you may lose your principal if traded incorrectly.
To keep it in basic terms, an option is a contract that allows you to purchase or sell a stock at a specific price before or on a particular date.
Each option contract is 100 shares of the stock.
If purchasing a call option, the contract gives you the right and not the obligation to buy the stock at a specific price.
If purchasing a put option, the contract gives you the right and not the obligation to sell the stock at a specific price.
If the price is never reached, then the options expire worthless.
I won't get into too many details about how options work as it gets technical (let me know if you'd like a post about this, and I will do my best to keep it in simple terms).
Novice investors often use options because they are a cheaper way to invest in a specific stock and a quick way to make returns, if any. The reason it may be a quick way is the compounding effects of each options contract as each one equals 100 shares versus purchasing perhaps only one share.
I've had conversations with clients who all have seen at least one form of social post where it "pitches" to them options trading. When I asked, "What do you think about options trading?" The typical response was, "It's a form of gambling because you are trying to predict the movement of a stock price to reach a certain price within a given time frame."
Options are advanced investments and should only be used by those investors who understand them and are willing to be able to take on substantial risk. Although often, many novice investors choose to invest first in options, are misinformed, and lose money quickly.
Lastly, not being adequately informed about the nature of the risks involved has led to those trading taking their own lives.
Momentum Strategy
The strategy that a creator often pitches is what the current trend is. This strategy is called a momentum trade. The way a momentum strategy works is to gain enough fanfare on a specific stock. Although this strategy works, initially, the momentum dies out at some point. Those who arrived late to the party or heard about it because of fear of missing out (FOMO) are the ones left holding a bad investment.
Investors are their own worst enemy. Studies have shown that over time, investors significantly underperform the markets because of behavioral tendencies as humans. Many investors buy at the wrong time: buy high and sell low as fear and greed overwhelm them. On average, day trading investors also do not make high profits or returns because a strategy they try does not work sooner or later, and therefore, they give up most of their gains.
Quite simply, a stock can move up or down on a given day, giving it the probability of moving in either direction of 50% unless moving systematically with the rest of the market, news on business fundamentals, or other outside factors. As stated before, most of the strategies touted by these posts are momentum strategies that push higher and systematically disconnect from the rest of the market or the business fundamentals. Momentum buying is trying to time the market, and therefore, if you enter this strategy at the wrong time, it may end up very badly for you if you buy in at the top. To keep the momentum going, you need more money and investors to keep the price up. Eventually, investors and funds evaporate as there is a finite number, which is how the momentum trade crumbles.
This strategy reminds me of the telephone game: where you sit in a circle (or stand in line), you whisper something in your neighbor's ear, and then they must pass this on to the next person until it reaches the end of the circle (line). When the phrase or word gets to the final person, it is like being the last one invited to the party. The telephone game is an example of what may happen with a momentum trade.
Once the strategy has gotten enough momentum (viewership/attention), the content creator may begin to sell out of their position. By doing this, you are left alone and "holding the bag," and the position may turn negative after this. This strategy is synonymous with what we call a "pump & dump" scheme in the industry. This scheme creates hype for a stock because it has perhaps performed poorly for them. Now, they are trying to get out of this position. Another reason is that many investors may easily manipulate the stock because of low trading volumes. Any sudden moves because previously the trading volume was low can create a significant rise. This positive momentum is boosted by posting their success because of their massive reach, and then once the strategy has performed for them to get a positive gain, they sell out, and you are again left "holding the bag."
Common Mistakes
I have had some potential client discussions in regard to situations like this. They viewed something from their social media; they tried to mimic it and lost money because they ended up on the wrong side. They got "burned" or "blown up their account." Most responded, "I am young. I can still make it back. I don't need the money anytime soon." Another response is, "But I only lost 75%. I can regain this loss. All I need is my account to back up by 75%."
I responded to them, "Well, that's great that you're young, but now have you considered that you have to save much more aggressively to make up this loss. Also, losses and returns are not symmetrical." Every time you lose big because of a bad investment, you must regain it at a higher percentage.
Consider this example of losing 75% of your portfolio value (or investment). Your portfolio (or investment) needs to increase by 300% to regain your original value!
Investment returns are not symmetrical!
(Please excuse my messy handwriting)
Crackdowns
The Australian Securities and Investments Commission (ASIC) recently released guidelines that target "finfluencers" (finance influencers) who are unlicensed and provide tips that promise significant returns or promise investments they recommend are as good as putting money in the bank.
These finance influencers may face five years of jail time or fines of over $1 Million if they provide financial advice without being properly licensed.
Update: The United States Securities and Exchange Commission (SEC) is starting to do its crackdown on social media influencers touting financial products.
In December 2022, the SEC charged seven social media influencers who used Twitter and Discord. An additional influencer was charged for aiding and abetting the scheme. These influencers passed themselves as "successful traders" and promoted stocks they would sell later once the price or trading volume increased. This type of scheme is called a "pump and dump" scheme. The result of the scheme allowed these influencers to profit more than $100 million.
After being charged with securities fraud by the SEC, these influencers began putting disclaimers on their social media. The same disclaimers were mentioned earlier in this article. Even after placing a disclaimer, this does not provide any form of coverage from illegality. This still does not protect anyone, even after the fact.
Your Takeaways
Remember, some content creators get paid for a viewing audience through advertisers; therefore, they make their money while you watch their content through the ads played on their videos. They gain more if they can also make a return on their strategy. This is what we call conflicts of interest. They may also be providing misinformation that may sound like they are professionals but have been trading for the past few months. Let me ask you this: Would you go to a doctor with only a few months of education? Why do you think professions such as doctors and lawyers require years of schooling?
But the most important thing to understand is they do not know your financial situation or risk tolerance. If these content providers are touting you a strategy that rushes up and down within the day or week (we call this volatility), you may be unable to stomach these wild swings. Therefore, they are not looking out for your best interest. These content creators have no fiduciary duty to put your best interest before theirs. They also do not understand your financial position. Perhaps you need this money to pay for something in the future. Maybe it is for a home, retirement, or whatever goal.
You have worked hard for your money and are on the right path to wanting to do everything yourself by putting it to work. Yet, you are at a higher risk of losing it, especially if you are trying to follow something you may not understand. Although there are videos out there that are educational, most content creators are supposed to do one thing: gain more viewership so the content provider can get paid. Therefore, these content providers are not financial advisors and have no basis for knowing you as a client.
Financial advisors are registered with the state or the Securities and Exchange Commission (SEC). They have a fiduciary duty to put your best interests before theirs and disclose any conflicts of interest. They also have to know you as a client. Their job is to offer you financial advice, whether in managing your investment portfolio, financial planning, or both. Some financial advisors post educational financial videos, but the nature of their videos is to inform and educate rather than sell.
Therefore, research the person/company who is showing you this strategy. Your instincts may be correct if you think it's too good to be true.
The SEC Advisor Search site is a great site to know if someone is registered as a financial advisor.
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