Market Sentiment or stock sentiment is a term used to describe the attitude of investors towards a particular security or the stock market in general.
‘Sentiment is a more ‘soft’ market indicator as it is not defined by strict rules derived from the security price series, such as with traditional technical indicators.
Instead, various ways to gauge investor sentiment exist with the intent to understand if the market is overbought or oversold. Overall, there are three different ways of understanding market sentiment:
Investor positioningInvestor positioning is used to understand investor sentiment by determining whether a group of investors are long or short.
One of the most famous indicators based on investor positioning is the CoT (commitments of traders) report. It is used in commodity markets to understand if speculative investors (or commercial commodity companies) are long or short in a particular market. A high reading on speculative long positions, for example, conveys overheated sentiment.
Market-derived sentiment indicatorsSentiment indicators which are derived from market prices, function in a similar way to technical indicators. Sometimes, they use different market instruments in a single indicator to aggregate the sentiment of cash, option and volatility traders. The most popular indicators are the Fear and Greed Index and the Put/Call Ratio.
The Fear-and-Greed Index is calculated using seven different indicators derived from market prices: stock price momentum, stock price strength, stock price breadth, put and call options, junk bond demand, market volatility and safe-haven demand. It plots on a scale of 0 - 100 the state of the market, where 0 means extreme fear and 100 extreme euphoria.
Social Sentiment indicatorsSocial sentiment indicators are relatively new. These indicators are calculated using millions of social media messages such as tweets or Reddit posts to understand if investors are bullish or bearish on a particular stock.
The methodology of calculation is usually not publicly available. Companies calculating those indicators, such as StockGeist.ai, use proprietary algorithms to analyse the data.
What is Social Sentiment
‘Social Sentiment’ in the context of trading refers to the attitude investors are displaying towards a particular stock or the market in general on social media.
Over the last decade, a number of social media platforms have become home to trading communities where investors discuss their portfolios and positions.
The most widely used platforms in this context are Reddit and Twitter. On Reddit, multiple communities or ‘subreddits’ exist dedicated to discussing investments. The most famous (or infamous) subreddit is r/wallstreetbets which has been widely covered during the meme-stock rallies in Gamestop, AMC and other names.
On Twitter, there is no trading community specifically. However, many users on Twitter write about investment ideas and their market thoughts using hashtags and $-ticker symbols when referring to a particular security. This microcosm has thus been dubbed 'Fin-Twit'.
All messages generated by users collectively can be used to determine the social sentiment towards a particular stock.
How to analyse social sentiment?
Social sentiment refers to a collective attitude of traders towards a particular stock or security.
Insofar, the opinion of a single, even if highly respected individual about a particular stock does not define the social attitude towards this stock.
In order to understand the social opinion about a particular stock, the aggregate sentiment needs to be determined - this can be either bullish or bearish depending on how traders and investors are viewing the market at the time. Visit bullish vs bearish sentiment for more information on how each differs.
To do this, companies specialising in big-data analytics such as StockGeist.ai harvest millions of tweets and messages on social media platforms such as Reddit in real-time.
The messages are then automatically analysed using machine learning models, which can determine the sentiment of a single tweet or message. To achieve this, the models operate using NLP (natural language processing) algorithms which categorise each tweet on a numerical scale, whether it is positive, neutral or negative.
The aggregate values of positive, neutral and negative tweets or messages are then used to calculate a social sentiment index score which can be plotted over time to understand whether the current sentiment is bullish or bearish compared to historical values.
Why do traders use social sentiment analysis?
Social sentiment is just one of many indicators traders are using to determine whether to enter or exit a trade. With so many different indicators available, why would traders use an extra indicator?
Different quality of information compared to technical indicators
Technical indicators such as moving averages, RSI and others are calculated using historical price data as input variables. Insofar, technical indicators are correlated with one another - using multiple technical indicators might help to time an ideal entry or exit. Still, it does not change the overall picture of a trade.
Social sentiment indicators, however, are calculated using qualitative data, namely people's attitudes towards a stock. Therefore, adding such indicators to a trading strategy might give an essential perspective on whether a particular stock is a good buy or sell.
Cryptocurrencies and meme-stocks trade on sentiment
Social sentiment data can be an advantage compared to classical technical indicators in markets that largely trade on sentiment, such as cryptocurrencies or meme-stocks.
When investing in stocks, people tend to look at fundamental value data such as the price/earnings or the price-to-sales ratio in addition to technical indicators. In traditional markets, this make makes sense because historically, there have been limits as to how far the fundamental value of a (blue-chip) stock can drop before the price eventually reverses.
However, a fundamental value is sometimes hard to determine with cryptocurrencies and meme-stocks. Thus, sentiment indicators can give a better understanding of when these markets are overheating or ‘underpriced’.
While social sentiment indicators are relatively new, they are gaining popularity amongst traders, in particular, to understand the behaviour of cryptocurrency prices and meme stocks.
These indicators can be a helpful supplementary tool to traditional market analysis such as fundamental and technical analysis.
It is important to trust the firm publishing the indicators that their data sources, models and algorithms are fit-for-purpose because the calculation methodology is not publicly available.
Would you like to try integrating social sentiment indicators into your trading? Sign up for a free trial at StockGeist.ai - we calculate the sentiment for more than 2,200 stocks, employing our proprietary AI-based deep learning solutions.