Does Social Media give you a Trading Edge?

In the past few years the Investor’s environment has either been managing a crisis or recovering from a crisis, and this lack of investor confidence has seen many timid traders running for the hills.  Sifting through the ‘noise’ of US Fiscal Cliffs, European Debt Crisis, not to mention France and Germany thrown into the mix, it is enough to make even the most astute investors turn off their monitors.  So why then are many investors turning into even more ‘noise’ in the hope to predict the likely future movement of prices?

The answer is simple, to quickly assess market sentiment across the world stage by providing a real-time analysis of market conditions, specific asset classes and securities or more commonly known as Social Media Sentiment Analysis.

Traditional investors are now being exposed to what the tech-savvy traders have known about for a while, the biggest shift in this generation’s information flow – Twitter.  The latest tools, specifically Twitter-based strategies, are being employed by various companies who offer a service to data mine every tweet that is produced on Twitter, and provide analysis on the flow of information and market sentiment.  Importantly these companies work out the best way to leverage the flow of information, to get through the ‘noise’ and provide a valuable volume of material to traders.

Experienced traders in the industry understand and appreciate that information released to the media is often already old news and asset or share prices generally factor in price shifts in the anticipation of information being released or potential actions undertaken.  With this in mind, the heady flow of instant information via millions of tweets each minute needs to be underpinned by appropriate IT infrastructure to ensure the fast and reliable flow of data to the trading environment.  A big call perhaps for service providers to ensure the social media monitoring engine is accurate, quantified and appropriate to the needs of their customers.  The trader’s data feed needs to provide strong indicators or actionable intelligence in order for this facility to better serve the financial sector, provide support and analysis to investment and trading decisions.

So while it appears on the surface that Twitter data feeds may initially just be adding to an investors ‘noise’ with some 350 million tweets daily, the idea of using social media to drive trading and investment decisions is gaining ground especially when you consider that Twitter information feeds often beat major news outlets to breaking events.  One example out of thousands is the news of Osama bin Laden’s death.  This crucial world news story was broken to Twitter followers approximately 20 minutes before the major media outlets.

In addition to pooling tweets for general market sentiment, commodities brokers and traders also pay close attention to the data obtained from farming centres of influence.  Farmers often tweet amongst themselves, alerting brokers directly to the potential outcomes of their crops potentially securing an edge in the market.  Twitter has become a real game changer for commodities market where once a broker might have needed to eyeball crops, they can now gather real-time updates on planting intentions and yields via tweets and sentiment data.

Not only does Twitter provide a ‘coffee house’ if you will for farmers to discuss weather conditions and crop yields for commodity traders, it also provides a platform for people to voice their opinions or concerns about other assets.  Take Hewlett-Packard for example, last week about an hour before they released their better-than-expected earnings the stock started to climb and people wondered aloud on Twitter about how HP could spontaneously rally into an earnings report.

For the traditional investors, traders and institutions who pride themselves on being at the forefront or the cutting-edge of information, this service is paramount to not only enhance existing strategies but potentially add value in other areas.  Risk mitigation and funds management are crucial to trading outcomes and observing the flow of money and information to or from certain assets, companies or industries is certainly useful.  Hedge funds and propriety trading houses are already employing technology via Twitter feeds to glean useful information and then take action accordingly.  Given most markets are driven by human fear or greed; this potentially gives them the jump on their counterparts who trade using more traditional forms of data.   Now it appears there is a way to quantify emotion and market sentiment in real time.

Whilst many investors believe it is a fool’s game to trade using market sentiment only, some believe it is a very useful tool in analysing asset price movements, measuring and tracking market sentiment with many providers of financial market data and trading platforms now adding social media functionality to their upgrades.  Firms such as Interactive Data, NYSE Technologies and Social Market Analytics (SMA) all now provide various aspects of topical and trending news sourced from the internet and social media.  It is just another source of information to understand what could be influencing the markets, what appears to be topical to the general public or what might be trending in the marketplace.

I personally haven’t used this kind of information gathering, preferring to stick to my tried and true traditional methods however there is merit around data mining as a valuation of individual stocks or value in sentiment analysis even if only as a trailing indicator.  I often have the 24 hour news channels running in the background of my office, certain screens monitoring important websites and always a list of what is due to be announced and when.  Other traders I know sit glued to their charting software or rely primarily on the resources of their platform providers.  Each investor will have their trading methods developed over time, and whilst the next generation is certainly embracing technology as a primary communication tool, it is still important to appreciate the social media framework is unfiltered and raw in its approach.

Social media is always embracing new initiatives and more recently, in addition to using Twitter to harness market sentiment, a new company Derwent Capital launched an online trading platform (called DCM Dealer) offering retail investors the ability to trade equities, foreign exchange and commodity contracts using a real-time sentient tool based on data produced by Twitter, Facebook and other social media channels.  The founder of this platform Paul Hawtin recently said; ‘Today, social media creates a vast amount of information and it has been proven that the sentiment derived from it can predict stock market movements. For the very first time, we are connecting this information source to the trading community, opening up the universe of social media data so traders can make more informed buying and selling decisions.’

This particular platform aims to include the ability of users to receive alerts and set limits when sentiment reaches a certain level, group stocks into portfolios to assess performance at an aggregated level and calculate a sentiment rating for individual stocks, indexes and commodities.  Whilst this initiative was the first online social media analysis platforms (certainly not the last), Hawtin recently used the power of social media to auction DCM Dealer to the highest bidder, which again was unprecedented.

On the topic of trading using Sentiment Analysis, Dr Daniel Beunza, Lecturer in Management for the London School of Economics (LSE), said that while it presented was an “interesting concept” for traders, its full potential had not yet been reached.  ‘One approach could be based on trending topics, which is different from sentiment,’ said Dr Beunza. ‘Another could be on semantic analysis, which is not just analysing the positive or negative, but the actual content itself.  However, I’m yet to see any companies adopt this approach yet.’

Whether you believe in harnessing social media and adding aspects of this technology to your arsenal of trading tools, or prefer to stick to your traditional methods, social media is here for the long haul.  It is the next generation’s ‘information flow’ and ironically is also extremely open, transparent and unfiltered easily allowing for misguided or mismanagement of information.

This acceleration of information, good or bad in its intention, creates a market sentiment that needs to be managed and interpreted hopefully in a succinct way that primarily allows traders to filter the extra ‘noise’, and provide support and analysis for their investment and trading decisions overall.

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