Social Media Investing
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Navigating the financial markets nowadays requires one of several options:
1. Pay thousands of dollars for a professional to manage your portfolio
2. Be a mathematical genius capable of creating an algorithm that beats the market with the help of a high-frequency trading platform
3. Attempt to invest on your own, which usually results in losing money to the previous two categories
This paradigm could radically change in a couple of years with the use of a simple free tool: social media.
Professional Twitter Analysis
Believe or not, researchers have found significant correlations between social media posts and the direction of financial markets. According to a Bloomberg article from late 2010, researchers at the University of Manchester and Indiana University found a way to predict daily changes in the Dow Jones Industrial Average by observing specific emotional keywords on Twitter.
“A change in emotions expressed online would be followed between two and six days later by a move in the index, the researchers said, and this information let them predict its movements with 87.6 percent accuracy.” - Bloomberg
The data was compelling enough for a group of investment managers to start a hedge fund based completely on tracking social media moods. Derwent Absolute Return Fund was funded initially with $39 million under management following trading models and algorithms that weighed sentiment on Twitter. Additionally, the models extracted data from the posts to know on which index to trade or if to buy or sell commodities such as oil, gold or even currencies.
The fund operated for a month during 2011, achieving a 1.86% return on its sterling shares, which fared ahead of the market and the average hedge fund returns. The fund was consequently liquidated as the managers believed it would be more profitable to sell the social media based trading platform to private investors rather than using it themselves. Paul Hawtin, CEO and Founder of Derwent, is aiming to attract between 3,000 and 5,000 customers to trade through its system, taking a cut from the trading fees charged from brokers.
The Value of Public Information
While this is only one example, maybe even a ~$40 million beta test, the prominence and importance of Twitter and other social networks to financial markets is undeniable. As of June 2012, Twitter reached 400 million tweets per day, up 60 million from the figure released in March of the same year. As people become more accustomed to sharing content online, it will be possible to get a more accurate read of market sentiment and be able to capitalize on it.
While it is evident that Twitter and social networks will provide massively valuable data for researchers and hedge funds capable of creating algorithms to trade on it, individual investors and companies should also be aware of how social media can help or affect their investments.
Starting with individuals, the use of social media will be directly related to the investing objectives each one has. For instance, value investors would probably not give a lot of value to market trends and sentiment as they look for fundamental long-term value in companies. Momentum investors or high-frequency traders could really take advantage of sentimental swings on the other hand, given that they look for short-term profits and a quick way to realize value.
By creating lists of interesting stocks, individual investors could quickly weigh what is being said of the respective companies and use the information as a factor on whether to trade or not. This information is in no way a replacement of techniques such as fundamental or technical analysis, however, it can provide a unique advantage in relation to the rest of the market.
Companies on the other hand can use the same type of information to understand where their stock price is heading – public companies at least – and take preemptive measures if necessary to avoid unwanted volatility in case of negative events. For instance, a public relations scandal could significantly affect a company’s stock price in a matter of days, but such negative reactions will be available in a matter of hours on social media platforms so an official statement could be released or an apology issued.
The power of social media is more evident in our daily life, be it in local elections or international politics, and the influence it will attain in financial markets and investments will greatly change the normal way of looking at the art of investing.