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Trading Off the News: Applications of News Algorithms

Trading Off the News: Applications of News Algorithms. July 1, 2008 CARISMA 2008. Alan Slomowitz Director Product Development Algorithmic and Trading Solutions Dow Jones Content Technology Solutions. Trading Off The News - HP to Acquire EDS.

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Trading Off the News: Applications of News Algorithms

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  1. Trading Off the News: Applications of News Algorithms July 1, 2008 CARISMA 2008 Alan Slomowitz Director Product Development Algorithmic and Trading Solutions Dow Jones Content Technology Solutions

  2. Trading Off The News - HP to Acquire EDS 15:02 *WSJ: Hewlett-Packard In Advanced Talks to Acquire EDS 15:02 *WSJ: Hewlett-Packard-EDS Deal Could Come In Matter Of Days 15:03 *WSJ: Premium Expected To Be In 30% Range –Sources 15:03 *WSJ: EDS Overall Price Roughly $13 Billion -Sources >HPQ EDS Source: DJ Newswires

  3. 3 News and the Quantitative Investor:The New Frontier • Successful trading is about finding the crucial edge • First to take advantage of trading opportunities • Quantitative investors require: • Analytical hypotheses • Technology • Data • Data = News • Exploit this new information source • Difficult-to-quantify qualitative content

  4. 4 Taking Advantage of the News • Intuitively, investment professionals realize you can use news to create profitable trading models • Proprietary traders, Stat Arb desks and hedge funds now use news to create Alpha-based trading strategies • News based algorithms that can profit from market anomalies lasting from mere milliseconds to days or even longer • Economic indicator based algorithms • Corporate news based algorithms • News-based algorithms are valuable additions to Alpha generation: • News is difficult to integrate into investment models • Difficulty means higher value – not so easy to commoditize • Requires different tools – both data and text analysis tools • Different ways of analyzing market trends

  5. Making News Work for You: Tagged, Machine-Readable News Feed • Economic Indicator-Based Algorithms • Arms Race – Must have a global, reliable and innovative news provider • Latency matters • FX and Futures markets • Multiple markets and countries • Corporate News-Based Algorithms • Scheduled events: Earnings, Guidance • Unscheduled events: Mergers, Ratings changes, Executive changes • Text mining events: surprise and sentiment • Analyzing the language of the news • Quantifying that analysis

  6. Solving the Corporate News Puzzle • Expected Corporate News Events • Plan for releases incorporating expected, historical and actual data • How long does it take for market to assimilate this news • Unexpected News Events • Cannot build an alpha algorithm for every unexpected event • Anticipate a controlled set of pre-defined news events • Ratings changes, executive changes, dividends • Capability to stop algorithms that are in flight when such news events occur • e.g., HP announces purchase of EDS • Adjust trading strategy for significant events

  7. Solving the Corporate News Puzzle (cont.) • Complex Event Processing • Multiple signals combined • If EPS > X and Price moves > 3% in 5 minutes and market is up less than 1% Then BUY XXXX shares • Academic Research

  8. Paul Tetlock, Quantifying Language to Measure Firms’ Fundamentals (Sept 2006/May 2007) Linguistic media content captures otherwise hard-to-quantify aspects of firms’ fundamentals, which investors quickly factor into stock prices Simple counting of negative words can uncover negative sentiment in earnings releases Antweiler and Frank, Do U.S. Stock Markets Typically Overreact to Corporate News Stories? (October, 2005) Initial returns jump is typically accompanied by a temporary jump in trading volume Reversal is typically accompanied by gradually declining trading volume During business cycle expansions, the process is largely complete after two or three weeks During recessions, the reversal is much more prolonged and we are not able to identify a clear point at which the process ends 8 What the Academics are Saying

  9. Paul Tetlock, Giving Content to Investor Sentiment: The Role of Media in the Stock Market, Journal of Finance (June 2007) Academic Bibliography available 9 What the Academics are Saying (cont.)

  10. Trading off Positive/Negative Word Counts • Long/Short Portfolio • Firms with positive news – Long • Firms with negative news – Short • Hold for one trading day • Rebalance at end of next trading day More Than Words – Quantifying Language to Measure Firms’ Fundamentals May 2007 – Tetlock, Saar-Tsechansky, Macskassy

  11. Abnormal Event Returns 10 Days Prior and 10 Days Post News Releases S&P 500 Firms All news stories with a fraction of negative words in the year’s top (bottom) quartile as negative (positive) stories Compute difference between reaction to positive and negative news stories More Than Words – Quantifying Language to Measure Firms’ Fundamentals May 2007 – Tetlock, Saar-Tsechansky, Macskassy

  12. Cumulative Standardized Unexpected Earnings (SUE) Cumulative SUE 10 quarters prior to news and 10 quarters after news Negative stories 30 days prior to earnings announcements More Than Words – Quantifying Language to Measure Firms’ Fundamentals May 2007 – Tetlock, Saar-Tsechansky, Macskassy

  13. 40 Minutes of Alpha S&P 500 Companies Beat the estimates and you are king … Miss your estimates and you get hammered … For 40 Minutes! Research in Progress

  14. News Impacts: Some Examples • Rapidly changing market conditions and news events alter market prices and expectations • Belief is that prices should fully reflect expectations • News events do have significant effects on market prices and returns • Merger announcements • Earnings guidance • Interest-rate cuts

  15. Bank of America to Buy Countrywide

  16. GE Earnings Guidance Source: DJ Newswires & MarketWatch

  17. Bank of England Cuts Rates * DJ Bank of England Cuts Bank Rate To 5.25% From 5.5%

  18. 18 Good News/Bad News – Profit from Both • The Ultimate Challenge: Deriving tradable meaning from the news • Start with publicly available content like DJ News, press releases, EDGAR filings • Determine analytical methodology • Back-test and determine viability • Integrate multiple models, sources • Apply to real-world • Requirements • Large archive • Text mining tools • Sentiment models • Skilled analysts

  19. 19 Potential Alphas • Profiting from expected events • Economic data changes • News and momentum: • Evidence that news gives rise to long- and short-term momentum in prices • Overreaction and underreaction: • On news releases, stocks overshoot with prices misaligned with fundamentals • Sentiment - Count of negative news: • A simple count of negative words in news has proven to provide strategies with positive Alpha

  20. Profiting From News Has Its Challenges • What news events to capture • Economic data, Earnings, Guidance – the easy stuff • Mergers & acquisitions, executive changes, bankruptcies – that’s tough • Sentiment - ?? • Many news feeds are not tagged or machine-readable • Need to parse, automate, and digest news • Web-based content is another major challenge • Need to determine: • Which news is relevant? So many sources! • How to react to unexpected events? • Trusted sources • Is news already factored into price? • Which direction will news push the price?

  21. Final Thoughts • Electronic and Quantitative Trading market is rapidly evolving • News is an increasingly important driver of automated trading strategies • Growing number of tradable news events • News data algorithms • Economic data; earnings and guidance • Elementized News events • Ratings changes, mergers & acquisitions, executive changes • Trading on planned events is profitable • If you can react quickly enough • Not paying attention to news can cost you • Lost Alpha opportunities • Outright losses

  22. Transforming News For Quantitative Trading And Research Dow Jones SolutionsFor Algorithmic & Quantitative Trading • Suite of advanced information and technology tools for a performance edge • Unique news data, tagged and elementized • Computer-readable • Flexible, ultra-low-latency delivery options and seamless integration • News sentiment tools • 20-plus-year news archives for back-testing ideas • Tools for creating, deploying and adapting complex, news-based trading strategies • Products • Dow Jones Elementized News Feed • Economic Data – Major economic indicators • Corporate Data – Earnings, Guidance, Mergers, Executive Changes, Ratings, Bankruptcies, more • Dow Jones News & Archives for Algorithmic Applications • 20-plus-year archive of news for analysis • Viewer and toolkit available • Dow Jones News Analytics • News transformed into actionable data • Derive analytics based on sentiment, volume, more

  23. 23 Trading Off The News Questions?

  24. Trading Off The News: Applications Of News Algorithms Alan Slomowitz: alan.slomowitz@dowjones.com (201) 938-2195

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