When it comes to predicting market behaviour, social media is more than just noise. After analyzing millions of investor posts, Assistant Professor Runjing Lu of the Department of Economics and her co-authors have shown that social media can yield valuable signals for understanding financial markets. The key to unlocking these signals means distinguishing between how investors feel, or their sentiment, and what investors choose to focus on, or their attention.
The study, Market Signals from Social Media, examined millions of daily posts made on three different social media platforms between 2013 and 2021.
“We constructed indexes using data from StockTwits, Twitter, and Seeking Alpha, platforms where investors actively post,” Professor Lu explained. “What’s unique is that we separate sentiment from attention. On these platforms, users express both their opinions about how bearish or bullish they are about a stock, which gives us sentiment, and their focus of discussion, the stocks they talk about, which gives us attention. We then aggregated these signals across firms and platforms to create separate daily indexes for sentiment and attention that reflect overall market mood and focus.”
Market sentiment and attention have distinct dynamics and differentiating sentiment and attention can help investors more accurately see how the markets will move next.
“We found that market returns rise prior to high sentiment days, followed by a reversal over the next 20 days, but returns decline prior to high attention days, followed by a continuation of negative returns,” said Lu.
In other words, when market attention is high, future returns are lower, but after drops in sentiment, returns tend to recover. According to Lu, a trading strategy based on these patterns earns an average excess annual return of 4.6% with a Sharpe ratio of 1.2. This represents a solid showing by Wall Street standards.
Another unique feature of the study is its focus on retail, or individual investors, rather than on institutional traders. That focus reflects a trend that has only recently been growing in influence.
“Before COVID, institutional investors dominated the U.S. market,” Lu said. “After the pandemic, with the rise of low-fee brokerage houses, there was an influx of retail investors. That’s when everyday people started playing a bigger role in the financial markets, and social media, capturing their sentiment and attention, started to matter more in aggregating information and moving markets.”
Although market-level sentiment and attention are valuable for capturing broad market movements, not all social media information is equally useful. The Social Signal, an earlier study by Professor Lu and co-authors, shows that sentiment from professional investors at the firm-day level is more predictive of next-day returns than advice from novices or influencers.
“When you think about who to listen to on social media, it’s the people who have experience and good track records who should be at the fore, not just anyone with an opinion,” Lu cautioned. “Social media is not just noise. It’s a real-time reflection of investor psychology, and when used carefully, it can offer valuable insights.”
Return to the Department of Economics website.
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