How to Use Twitter to Guide Your Investments

@MikeSchultz: Hot tip – invest in ZRA

@WholeWorld: RT @MikeSchultz Hot tip – invest in ZRA

OK, it’s not quite that easy (and anyway, you don’t need a tweet to know that Zirra’s worth investing in). But more and more investors are looking to Twitter as a crucial source of information, or even as the primary driver for their investment strategy.

Things started getting excited for Twitter-based investing when Professor Johan Bollen, of Indiana University, found that you could look at the whole set of tweets, on any and all subjects, use sentiment analysis to find out the worldwide mood, and predict what would happen to the Dow Jones Industrial Average 3-4 days later, with 87% accuracy. More specifically, whether or not the worldwide mood, as expressed in its tweets, was “calm,” predicted the direction of the DJIA 87% of the time, which is very impressive.

(Now, to be fair, he didn’t really look at the whole world of Twitter, just the English language tweets. But technology has improved – for example, since 2013 Lexalytics offers sentiment analysis in Mandarin – so that problem can be resolved.)

Additional studies confirmed his findings, even using simpler versions of sentiment analysis, also adding “happiness” as an additional mood that predicted the direction of the stock market, and confirming that it doesn’t work for same-day predictions, only with a lag of a few days.

Buoyed by the good news that Twitter could make you rich, Derwent Capital Markets launched its “Absolute Return” fund, a hedge fund entirely driven by Bollen’s suggested approach. This would’ve been a really exciting experiment to watch, and it beat the market in its first month. But then sadly, the “Twitter Fund,” as it was known, abruptly closed, because it had almost no investors. It turned out that almost no investors were comfortable trusting the mood of the masses. It doesn’t mean it was a bad strategy, it just means that this kind of thinking, finding – and trusting – investment information gleaned at a far remove from “the experts” wasn’t something investors were comfortable with.

Times change, though, and within a few years the number of companies trading based on Twitter data, though still small, is growing. The quality of sentiment analysis continues to improve, and more importantly, investor conservatism is giving way to growing acknowledgement that the world as a whole knows more than the experts, and Twitter is a good way of accessing that collective sense.

There are a variety of approaches out there. One idea is to use data analysis or sentiment analysis in order to gain key information about impending changes. If you know from Twitter that something’s about to change, even if you just know it a couple minutes before the rest of the world, that can be huge. You can look just at the tweets of financial insiders, now included in Bloomberg’s delivery service, to gain insight into how things are shifting in a particular market a few minutes before it actually happens. Or you can look at the tweets of the entire world to identify on-the-ground breaking news that, so long as you correctly interpret the implications, tells you to buy or sell, right now. That’s the service offered by companies like Dataminr – breaking news that clearly will affect the value of specific companies or specific markets, you just need to act on it fast.

Another approach is to look just at tweets that are tech or stock related. One study found that without even looking which stocks are being talked about, you can know whether the market will be going up 90 minutes later. Turns out there are certain keywords that bode well for the market. Wait until those key words are buzzing on Twitter and you know it’s time to buy.

Finally, how about using Twitter sentiment analysis in such a simple, obvious way it almost feels old-fashioned? Analyze all the Twitter feeds referencing stocks, and see which stocks are being tweeted about most favorably.

That’s what Market Prophit is now doing. Since May of this year, they operate a Social Media Sentiment Index. Looking at the S&P 500, they choose 25 companies to include in the index, based on Twitter sentiment analysis as well as the sheer volume of tweets to see who’s being talked about most.

In a certain sense, what they’re doing, to aggregate the crowd’s thinking about these stocks, seems very similar to what the stock market itself does. But maybe the difference is that in the market itself, buyers’ and sellers’ choices are dependent on what they think other people think of those stocks – i.e., how high will others buy it from them, or how low will others sell it back to them. Whereas on Twitter, you’re closer to getting people’s actual feelings about the stocks.

Weirdly, at the same time as offering their index, so clearly based on the wisdom of crowds, Market Prophit also has a service trying to identify those financial bloggers who are the best of the best, the so-called Market Prophits. The theory of collective wisdom shows that the crowd, as a whole, consistently does better than the so-called experts, who do well for a while and then don’t do so well for a while. People’s comfort level with trusting the collective wisdom is growing, but there’s still a lot of ambivalence and a lot of holding onto the old “find the expert” way of thinking, and here you can apparently see that even within the same company.

No need to find the prophet – we’re all prophets, together.

Mike SchultzAugust 28, 2015

Mike Schultz

I am a contributing author who writes about crowd wisdom. I love reading broadly and synthesizing diverse sources of wisdom, but it's so cool when you realize the crowd itself does that even better.