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Positive sentiment: trading the news

First Published 23rd June 2014

How do traders harness the power of news flow? Automated Trader checks out UNICOM's sentiment analysis conference.

Louis Scott, Founder, Kiema Advisors

Louis Scott, Founder, Kiema Advisors

"News really does matter but it matters in terms of the volatility it creates rather than the alpha that you can harvest."

London - The idea that news flow can be systematically traded is becoming widely accepted. And not just for major news agencies commenting on planned announcements. Increasingly, social media is coming to the fore.

Last week, UNICOM's fourth annual conference looked at the application of sentiment analysis on models of trading, fund management and risk control from a wide range of disciplinary perspectives: pattern recognition, machine learning, syntax technologies, quantitative finance, and academia.

Not surprisingly, Thomson Reuters and Bloomberg have both upped their game in combining financial and editorial aspects of the business to provide analyses engines on trading screens.

Interest in developing technology is clear - a tweet from the right account can mean market movements. Recall the "hash crash" event last year, when a fake tweet from a hacked Associated Press account reported that US president Barack Obama was injured in a White House bombing caused the Dow to drop 145 points.

So, there is little doubt social media is being monitored and measured. But as machine learning gets deployed to make rapid assessments, the big question is: does sentiment analysis work?

In terms of finding alpha, the jury is out, said Louis Scott, founder of Kiema Advisors, who was presenting joint research with Northfield Information Services. A few of the presentations, he pointed out, throw a wrench into the news analysis engine.

Marco Dion, head of central risk book trading desk at JP Morgan and previously global head of the firm's quant research team, presented research that showed results in terms of alpha did not translate to huge profitability. Most alpha was found in small-cap stocks, and by the time transaction costs are added any value quickly disappeared.

Why alpha disappears was explained by research focused on risk transfer in the context of informed trades from Anna Obizhaeva, faculty at New Economic School in Moscow. Her team found that the more news there is, the more time compresses. The amount of time for an actionable news event to receive validating information flow varies widely.

For large caps that time is measured in milliseconds. For small caps, that could be minutes or even days, said Northfield's Louis Scott.

Scott's presentation went further than the notion that alpha disappears, but importantly, that risk lingers. He measured volatility on 400 large caps traded on the NYSE and NASDAQ, including ETFs (Exchange Traded Funds) and ADRs (American Depositary Receipts), where news should be most prevalent, controlling for unanticipated news such as conflicts breaking out or a CEO being fired.

Scott's findings show that volatility over a five-day horizon can be double what it would have been without the news.

"News really does matter but it matters in terms of the volatility it creates rather than the alpha that you can harvest," he said, speaking to Automated Trader. "Machine learning and applying statistical techniques are suitable for repeatable experiments or applied to physical systems, which are predictable, where markets are not."

Still, the use and analysis of both structured and unstructured news flow is sure to continue to receive attention and investment, to some degree because of the implications for market surveillance and operational risk control.

During a panel discussion, Richard Peterson, CEO of MarketPsych Data, said that especially in social media, his company identifies sophisticated attacks to manipulate trading behaviour. Botnets are hacking accounts on message boards and setting up Twitter accounts, all the time cultivating a reputation with real users by, for example, posting generic comments about a company. A year later, the Botnet recommends buying a stock.

Peterson took his findings to FINRA (Financial Industry Regulatory Authority), but said there was little interest in investigating the behaviour. "Basically, they don't have the resources to look into it," he said.

Also speaking on the panel, Simon Townsend, R&D director of Cloud Compliance at NICE Actimize, said that rolling up news analytics into trade surveillance adds significant understanding to what might be behind market movements.

"This really helps us drive up the detection rate for abuse and most particularly drive down the false positive rate," he said.