It's Getting Crowded

Gather several geese together and you get a “gaggle.”  An assembly of rhinos is a “crash.” And a collection of giraffes makes for a “tower” (really).  So what do you call a bunch of self-directed bullish and bearish traders?  According to a Bloomberg piece last week on social investing, they’re likely to be “copycats.”

The article outlined the remarkable growth of networks such as EToro and ZuluTrade and detailed the spread of mirror-trading functionality (by which participants can copy each other’s trades).  According to one study referenced in the article, one in six brokers now offers clients the ability to duplicate other users’ transactions.  One in six.

The trend toward more participation and transparency has been growing for several years in the brokerage space, with a variety of launches and “pivots” leading not just to trade sharing and duplication strategies but also to features like information and analysis aggregation (e.g., Seeking Alpha, Motley Fool) or advisor curation (Covestor) or all of the above (StockTwits).

We love the trend.  But we’re on the verge of a “too much of a good thing” problem.  These companies combine for several million customers, and there are dozens of other efforts – including some that help traders duplicate more-established investors like Warren Buffet and Carl Icahn.  Even if only 1 in 100 participants is making money and sharing trades, potential advisors already outnumber investment instruments by an order of magnitude. 

In short, we’ve traded one research problem for another, and picking a good investment manager isn’t THAT much easier than picking a good investment.  Look around and you’ll see the places that downplayed stock selection tools when they began to let their clients copy other traders are now bringing back the same kind of tools – to filter through advisors.  (Covestor even offers advisors that help you pick advisors.)  If you don’t change your mindset, solving a problem with crowdsourcing just leads to a problem of crowdsorting.

So what would a change in mindset look like in this space?  We suggest packs over picks.  That is, rather than putting all of your energy into identifying one or two great traders to copy, spend half of it sorting good traders from bad and then the other half following what more of the good investors are doing.  We can confirm after several years’ experience that this is much easier said than done, but it is still the right direction to head. 

Most people have heard the notion that foxes know many little things while the hedgehog knows one big thing.  We don’t think anyone is all fox or all hedgehog (except for, you know, a fox and a hedgehog).  We believe we can generate returns beyond any single participant’s ability if we can just find the bit of hedgehog in most investors (and bloggers and analysts).  And do you know what do you call it when you get a bunch of hedgehogs together?  An Array.