Traders Who 'Sync Up' Make More Money
The more instant messages by traders are in sync the likelier stock returns will be betterMarch 16, 2011
The more the instant messages (IMs) came in waves -- different from what would be expected if the IMs were sent and received randomly, as in casual conversations -- the more synchronous trading became. And the higher the traders’ synchrony, the more likely they were to make better returns and dodge losses.
Instant messaging -- commonly called “IMing” -- is part of a trader’s daily routine. As ever-changing news on the housing market, the Federal Reserve, job figures, bankruptcies and other global data pours in, traders need to quickly figure out which information applies to their stocks and what should be done about it. No one person could successfully sift through the flood alone, so traders try to figure out the meaning by IMing bits and pieces of information with their IM network of contacts.
A team composed of a sociologist, an engineer and an economist at the Kellogg School analyzed the actions of financial traders and found that trading in sync increased profits. Further, they found that synchrony arose spontaneously via instant messaging rather than through the direct guidance of a news broadcast or a mandate from a leader.
“For a long time we’ve known that people trade stocks based on information,” explains Kathleen Hagerty, a professor of finance at the Kellogg School and an author on the paper published in the Proceedings of the National Academy of Sciences.
“If big news comes along, like a blown-up refinery in Libya, there’s a good chance people will trade on it,” she said. “But it’s not like they just read the news and press ‘buy’ or ‘sell.’ The time to trade is after they’re fairly sure about what the news means to their stock, but before other people move on it.” She suggests that instant messaging speeds up the process of picking the right moment.
Besides Hagerty, the co-authors of the paper are Brian Uzzi, a professor of management and organizations, and Serguei Saavedra, an associate research professor and lead author of the paper, both at Kellogg.
As waves of IMs formed -- as opposed to a random distribution throughout the day -- individuals increasingly traded within seconds of each other, and paused at the same time, too. The individuals trading during the same interval typically dealt with unrelated stocks, ruling out the idea that the market was directly guiding their choices. Instead, cues from the market triggered IMs, which in turn influenced synchrony.
“If external stimuli were guiding trades, the stock market would be easy to figure out,” explains Uzzi. “Synchronization is telling us something unique about the system that no individual trader could tell you on their own.”
The Kellogg team chose to study traders because their environment is fluid and unpredictable -- analogous to that of synchronously chirping cicadas during the mating season. Animals are thought to manage risk through synchronous behavior that spontaneously arises without leadership. Thus, it is most apparent when risks loom.
In the case of cicadas, synchronous chirping throws predators off their trail. Likewise birds often launch simultaneously in response to a loud bang and form a dense group in the air. In doing so, they are thought to gain a heightened ability to collectively access and process information from widely distributed sources.
The reason sync is thought to exist is that any single animal on its own cannot process the complex information its sometimes faced with. “So when complexity increases, the animals appear to manage it better with a collective response that emerges from their individual responses, even though they are not trying to coordinate,” explains Uzzi. “We’ve seen this in nature, and we were excited about the prospect of it happening in human systems.”
The idea that collective genius can surpass the intellect of a single person is very radical, according to Uzzi. “But I think we are entering a time right now where there is a growing sense that collective dynamics may help us solve tough problems that a single genius simply can’t.”