Losers Are Easy to Spot

| Tue Aug. 23, 2011 11:10 AM EDT

A new NBER paper suggests that you can make a lot of money by following the crowd:

We study the predictive power of approximately 2.5 million stock picks submitted by individual users to the "CAPS" website run by the Motley Fool company (www.caps.fool.com). These picks prove to be surprisingly informative about future stock prices. Indeed, a strategy of shorting stocks with a disproportionate number of negative picks on the site and buying stocks with a disproportionate number of positive picks produces a return of over nine percent per annum over the sample period.

But wait. Negative and positive recommendations are asymmetrical:

These results are mostly driven by the fact that negative picks on the site strongly predict future stock price declines; positive picks on the site produce returns that are statistically indistinguishable from the market. A Fama French decomposition suggests that these results are largely due to stock-picking rather than style factors or market timing.

Take this for what it's worth. Which is to say, probably nothing now that it's been written up. Still, it's interesting stuff: apparently amateur stock pickers aren't that great at picking winners, but they sure know a loser when they see one.

(Via Matthew Kahn.)