Trading on Twitter

John Bates looks at one of the ways in which new tools may help organisations harness social media profitably

In terms of combining sentiment analysis with response to real-time events, the good news is there are now sophisticated real-time technologies on the market that can monitor and respond to market patterns, such as Complex Event Processing (CEP).

These patterns may represent trading opportunities as well as risks and threats – such as unusual market movements or risk thresholds being breached – for many business customers served by the IT channel.

CEP is now being used to analyse Twitter sentiment as well, combining both sentiment and the ability to respond to events.

This can be really useful to businesses, and therefore the IT channel as well.

Let me explain. UK hedge fund Dewant has bet £25m that Twitter can predict swings in the Dow Jones Industrial Average with 87 per cent accuracy. But, while this sounds super-cool, it is my view that predicting stock market moves using Twitter alone is about as reliable as a witness in the Raj Rajaratnam insider trading trial.

The first problem is that Twitter is not secure. I could tweet anything, such as 'US declares war with France'. If that's really happening, we should certainly react – but I could have made it up. If I have a million followers, they may think it's hilarious to retweet it, whether it is true or not. But how should a prediction algorithm respond?

The second problem is that, when it comes to mainstream news, it is highly unlikely that Twitter can provide business-critical information to traders quicker or more efficiently than a real-time news source such as Reuters or Bloomberg. When the news media put out a story, interested parties can then retweet that story. From an algorithmic standpoint it is a lagging indicator.

The third problem is in using global sentiment as a predictive indicator. Tools that can analyse all tweets to guage global sentiment on particular topics such as the economy are incredibly exciting. The results can represent a snapshot of a global consciousness. And the global view removes the noise.

But by the time we've built up a picture of the global sentiment, it's a trailing indicator and the real-time sentiment may have changed. A real-time event, such as a war, a market crash or an announcement, may occur that completely changes what the market is thinking.

Yet Twitter analysis done right can provide a view of global sentiment that we can use to learn all sorts of fascinating things.

Twitter is a great tool for judging whether the public is fed up with the royal wedding, or for getting your latest personal opinion out to the masses. However, alone it is not a credible source for predicting market swings.

Market sentiment is one indicator of how the market is going to perform. Combining that sentiment with the ability to respond to predictions of how it will move, or to real-time events, is often the key to success.

Sometimes betting against market sentiment can provide fast, substantial gains. For example, we have recently seen many investors advised to ignore market sentiment and bet that the Swiss franc would surpass the US dollar by the end of a particular week. Those who participated in that trade booked large gains.

It is more important than ever to know how to track sentiment. Globalisation has increased complexity, as well as uncertainty, at all levels of investment. All this is reflected in the correlations between different markets.

An event-risk in one market quickly cascades in other markets. For instance, when the Irish run into financial trouble, the euro weakens and risk appetite around the world shifts into risk aversion. The challenge is to be able to detect both direction and points of inflection in global sentiment.

Hence, CEP.

John Bates is chief technology officer at Progress Software