Twitter Could Be the New Stock Market Bellwether

In the never-ending chase to improve returns on stock portfolios, several are turning to Twitter as a guide to their investing. Chief among them is doctoral student Timm Sprenger, at the Technical University of Munich, who has launched a new site called TweetTrader that allows investors to see in real-time the projected stock sentiments from tweets.

While this could easily be dismissed as a cash-in fad, there is some research to back it up. Sprenger himself wrote a paper on the subject, as reported by GigaOm:

According to Sprenger’s research, the sentiment rankings that his system extracted matched the ebb and flow of the Standard & Poor’s 500-stock index fairly closely, and appeared to predict movements in the market by more than a day. The researchers said that any investor who bought or sold using their analysis in the first half of 2010 would have achieved an average rate of return as high as 15 percent.

The idea is that with millions of people constantly tweeting, TweetTrader reckons that some of those tweets will be about stocks and aggregates accordingly. The result is an overall temperature for the market — bearish or bullish — and some stock-specific information, all taken from tweets. If it operates in a manner similar to the methodology outlined in his research paper, then it is also looking for the best investment information, which Sprenger found was retweeted more often by Twitter users.

Sprenger is not alone in his findings, as others have sought a link between Twitter and stock returns. Researchers with Indiana University and the University of Manchester wrote the descriptively titled paper “Twitter mood predicts the stock market,” in which they predicted the Dow Jones industrial average correct 87.6% of the time. Unlike Sprenger, however, the IU/Manchester team did a broader analysis, looking for key mood-indicator words instead of stock-specific information. Interestingly, when using this method the team found that the affect on the Dow was found to occur two to six days after the mood of tweeters was taken.

The final vote of confidence in Twitter’s prognosticatory powers comes from Derwent Capital Markets, a hedge fund that has put its money where its mouth is and announced that it will use Twitter analysis as a key part of its investment strategy for one fund. The fund, called the Derwent Absolute Return Fund, launched this past February.

Monitoring Twitter is not without its drawbacks, of course. Because Twitter is an open system, it could conceivably be used by nefarious individuals to create positive or negative buzz about specific stocks. If their method catches on at all, Sprenger and others like him will certainly face such attempts and will have to plan accordingly. But with the interest expressed in these new analytical tools, and hefty investments already in place, it’s a near certainty that Twitter analysis is now part of the investing game.

(via GigaOm, image via Wikipedia)