Life happens on social media first. When North Korea fires a ballistic missile, Korean news agencies tweet about it. When President Donald Trump has a beef with Amazon.com (ticker: AMZN) — or anyone, really — he tweets about it.
Social media is becoming “a place where decision-makers go to share information,” says Adela Quinones, news product manager at Bloomberg LP in New York. From public figures to company spokesmen, people are increasingly using social media to update the world about events that affect stock markets.
And why not? Social media is an effective means of mass communication. It’s like “a megaphone where pieces of information can be quickly and broadly shared,” Quinones says. Rather than holding a news conference, a company can publish a 280-character tweet and let its followers do the broadcasting.
Twitter ( TWTR) in particular “allows ideas to spread as quickly as a virus spreads in the human population,” says Andrew Lo, a finance professor and director of the Laboratory for Financial Engineering at MIT’s Sloan School of Management. As with humanity, one social media virus can bring down a whole company or even the entire stock market.
The day the Federal Reserve announced it would begin buying and selling Treasurys to stimulate the economy, the market fell nearly 3 percent.
Leading up to the announcement, Twitter sentiment had been very negative, says Pablo Azar, a Ph.D student at MIT’s Laboratory for Financial Engineering. By spotting this negativity and shorting the market beforehand, an investor could have gained almost 4 percent that day, according to research by Azar and Lo.
[Read: When the Market Hates Good News.]
Use social media to stay ahead of the news. If you’re waiting for the news to tell you what’s going on in the world, you’re already behind. Social media is where eyewitnesses report events first — even before news organizations.
“The news is reporting events after the fact, but Twitter and social media are reporting things as they’re happening,” says Ed Oliver, vice president of financial sales at Dataminr, a New York-based company that monitors Twitter to alert clients about relevant news and events.
For instance, when the European Commission approved Bayer’s acquisition of Monsanto Co. ( MON), a reporter on the ground tweeted about it two hours before the official announcement, after which Bayer’s stock rose 0.3 percent. “That real-time capture becomes valuable [to investors] because it’s ahead of the wider dissemination to the market,” Oliver says.
Having an early advantage is clearly compelling for traders who are after short-term profits, but long-term investors can also benefit from following social media. How people are talking about a new product or venture on Twitter, whether positive or negative, can help investors determine the potential long-term effects on the company’s share price, Quinones says.
Social media also helps investors understand stock and market movements. It may seem irrational for Amazon’s shares to plummet 4.4 percent until you see a blog post saying Trump threatened to use antitrust laws against the company.
Track Twitter sentiment to improve stock market returns. “For investors who want to keep their finger on the pulse, social media is an important tool,” Quinones says. Finding that pulse is harder to do.
In their research, Azar and Lo measured Twitter sentiment based on the emotional context of tweets about the Federal Open Market Committee (the Federal Reserve body that determines short-term interest rates) and used the results to predict market shifts. They found that strategies that went long or short on a market index based on this sentiment could increase returns, Azar says.
The same strategy can be applied to individual stocks. “Every security has positive and negative sentiment associated with it at any given time,” Lo says. Shifts in that sentiment “might signal a change in [company-specific] news or in the macro environment where the company operates.”
If you see a sentiment shift across hundreds of stocks, you know something big — like a market crash — is building. “When people start to get nervous, you can detect that very clearly in these kinds of sentiment measures,” Lo says. And when you do, you might want to reduce your risk level.
[Read: 5 Ways to Protect Against a Market Correction.]
Watch for changes in tweet volume. Changes in the volume of tweets about a specific company can be a sign of new information. For example, if the number of tweets about Starbucks Corp. ( SBUX) suddenly jumps, it usually means big news broke about the company, Quinones says.
How much and how quickly a piece of news spreads in social media is closely related to how the stock performs afterward, she says.
Clusters, or when multiple Twitter handles are simultaneously tweeting about the same thing, can also alert investors to breaking news, Oliver says. For example, when a gas hub exploded in Austria in December, sending gas futures soaring across multiple markets, U.S investors were first alerted to it by multiple eyewitnesses tweeting images of the explosion.
Weed out false reports. If there’s only one handle tweeting about something, chances are it’s not significant or may be incorrect, Oliver says. But when multiple handles start talking about the same event simultaneously, it’s probably real. In this way, “the clustering effect becomes a safety mechanism for reporting false positives,” Oliver says.
The exception to the cluster-validity rule is if the single handle doing the tweeting is a market influencer. When Tesla ( TSLA) CEO Elon Musk tweets, there’s no need to corroborate his information with multiple sources. It’s going to have an impact simply because he was the one who tweeted it.
Get professional help. Bloomberg offers social media monitoring and alert services for retail investors who prefer to let someone else do the legwork.
[Read: Hire a Financial Advisor If They Can Answer This.]
The Bloomberg Terminal includes access to TWTR <GO>, which allows users to search for tweets based on Twitter handles, topics, securities or people of interest, and TREND <GO>, a news-ranking function that lets users see which companies are generating the highest readership, the strongest sentiment or the most Twitter volume over a selected period. Users can also set up alerts to stay abreast of news and changes.
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How Investors Use Twitter to Beef Up Returns originally appeared on usnews.com
