By Faruk Jaffer, Chief Investment Officer of Index Gurus, Inc.

Ask any hardcore sports fan to predict a winner at the next event and you will get a confident answer. Surprisingly, many of these fans know the statistics about players more accurately than they know the birthdays of their best friends. Websites such as Yahoo Fantasy Sports cater to these hobbyists by allowing fans to make predictions on the outcome of sporting events.  Similarly, websites exist for communities of stock traders, allowing investors to share knowledge about predicted stock gains or losses. Where do these traders congregate in order to gauge market sentiment and to make better stock predictions?

The Leaders:

Previously, message boards, blogs, and company websites were the main platforms that investors utilized in order to share information with peers.  Realizing the needs of the investor community, many websites were created to fulfill this need on a wider and more organized scale. Traders use these websites to gain a better understanding of securities or the overall market, and to make a purchasing decision. Today, the most popular websites are PredictWallStreet, followed by Motley Fool CAPS, Cake Financial and Covestor.

These websites function in similar methods, each aggregating millions of investor sentiments about individual stocks and the market as a whole.  One of the main differences between the websites is the method of how user input is collected. For example, PredictWallStreet features a “prediction widget” on popular websites such as tdameritrade.com, zecco.com, Facebook, iPhone, yahoo widgets, etc. A prediction widget allows web users to send PredictWallStreet their opinions without visiting their website. The ease by which users enter their predictions has made PredictWallStreet the leader in aggregating predictions. Cake Financial, on the other hand, simply partners with brokerage firms to feature links back to Cake Financial’s website.

Another difference between the websites is the type of information collected. PredictWallStreet and Motley Fool CAPS collect prediction data, asking investors if they believe a particular security will go up or down, outperform or underperform the market. On the other hand, Cake Financial and Covestor analyze user’s trading data, whether a security was bought or sold.  The difference is important as prediction data is inherently forward looking and not yet incorporated in a security’s price contrary to trading actions.

Investment ideas:

Index Gurus, Inc. realizes that asset allocation is important and protects clients by advising them to invest in a diversified portfolio. Clients are therefore rewarded for the risk that they assume through equity ownership. Since the investments in a portfolio are selected in relation to time horizon and risk tolerance, every company, sector, and asset category is important to the big picture.

As an investor assembles and complements a portfolio with stocks, it is helpful to get ideas from users at stock prediction websites. An example user could be a computer scientist who prefers to use a particular software program over other similar programs. The scientist has enough knowledge to make a prediction about the direction of the stock and comments on why it stands a better chance than the competition.  These comments are useful because happy customers can indicate the future success of a company.

In addition to feedback from the investment community, PredictWallStreet analyzes its predictions using sophisticated quantitative models. The resulting daily forecasts are accessible to everybody who has made at least one prediction.  Historically, these forecasts have beaten the market many times. The exact performance of these forecasts is published in a white paper “Investing with PredictWallStreet Data”. Motely Fool CAPS has an extra category for ratings of companies that are represented by professional Wall Street firms. The other websites, Covestor and Cake Financial, present all the comments from the community without distinguishing the commentator’s track record. This method can be time consuming because some commentators leave messages without substantial analysis.

Observe successful investors:

The process of building a track record is established over time. An investor starts by entering an opinion about the direction of a price of a stock.  The more accurate predictions an investor makes, the greater his credibility will be amongst peers. Later, the investor will develop an accuracy score, based on a star rating, which is between one to five stars.  Although this star ranking is utilized by PredictWallStreet and Motely Fool CAPS, PredictWallStreet has the unique advantage by allowing investors to see the prediction consensus for different star ratings on its accuracy tab. This shows if the majority of 5-star investors predict in the same direction as the majority of 1-star predictors.

Cake Financial and Covestor connect members to individual predictors who rate the same company. The process starts when individuals construct a portfolio of their favorite companies. Composing the portfolio can easily be achieved by linking a web account to an external brokerage account. For example, an investor at TD Ameritrade can synchronize their account to match their portfolio on the Cake Financial website. Once synchronized, members at Cake Financial can find peers who actively share opinions and trade the same security.

For a typical trader who examines securities and indices on a daily basis, the tools at PredictWallStreet and Motely Fool CAPS are invaluable. Both websites allow one to immediately contribute an opinion and receive immediate feedback from highly ranked peers. This transparent structure also allows the viewing of all holdings actively followed by an individual investor.

Strength in numbers:

As two heads are better than one, it’s important to frequent a website with a lot of community feedback.  This increases the chances that more professionals are drawn to interact and debate with other members.  To test the websites, I used the ticker symbol for Apple (AAPL).  The returned results on September 26 2008 at 1:15 pm PST, showed that PredictWallStreet had the highest number with 153 predictions. Motely Fool CAPS had 40 predictions while Cake Financial only had 7 trades. Lastly, Covestor had 8 trades for that day.

PredictWallStreet uses aggregate votes to benefit short and long-term traders through a sentiment meter and sentiment trend charts. The sentiment meter is based on the predictions of investors which show shifts in how people feel throughout the day. The website displays a graph that easily identifies whether the general sentiment is bullish or bearish.  The common indexes displayed on this graph include the S&P 500, NASDAQ, and DJIA. Investors can access sentiment trend charts for a company after making a prediction for that particular ticker. These charts show continuous sentiment for several time intervals: intraday, week, month, 3 months, and 1 year. Sentiment trend charts also display if the sentiment is extremely up or down. In addition, the quote can be overlaid to see the relationship between sentiment and price. Observing a security’s sentiment trend gives insights into the emotional behavior of a security.

Conclusion:

The participants of investment community websites come from all walks of life. Many of them are stock gurus specializing in a particular sector. For example, a doctor advocating an external company based on the performance of a specific drug or equipment. The beneficiaries of this information are the investors who take the time to follow and learn from these experts. The opinion of the common investor is just as important because they have often researched the competition before making an educated prediction.

As an advisor and investor, I have benefited from the tools offered by PredictWallStreet and Motely Fool CAPS.  PredictWallStreet is my first choice for various reasons. The data collection process leverages external links to investors from mainstream investing institutions such as TD Ameritrade. As more investors participate in this community, the more confident I feel about the data which reflects the accuracy of individual predictors and the overall community sentiment.  Measuring how the community feels about indices and individual companies has been useful for making decisions whether to buy or sell a security. The website also allows the quick comparison of personal predictions to the sentiments of star performers. Individuals at PredictWallStreet with a solid track record have given me ideas for portfolio diversification and risk reduction strategies. Through financial rewards, recognition of being a stock guru, catching up on the latest buzz, or even mimicking the behavior of an expert, these websites are creating a new way to participate in the stock market.

About the author: Faruk has experience at various Wall Street firms which included retail, mutual fund and asset management. After discovering a fee-only model which allowed him to serve the client’s best interest, he created Index Gurus, Inc. Over the last four years, the team at Index Gurus, Inc. has served happy customers with investment management and retirement services in the Bay Area, CA.

Why I wrote this article: A few weeks ago, I contacted PredictWallStreet and expressed my accolade about their website. As a result, they asked me to evaluate the PredictWallStreet offering from a perspective of the financial advisor and compare it to some other sites. This article is a quick overview of my findings. While I am getting a small fee for this analysis, the opinions expressed are mine.