A hedge fund that uses Twitter data to drive its trading strategy returned 1.85 percent in its first month of trading, according to an investor in the fund, in the first sign that social media data can be used successfully to enhance electronic trading techniques.Not bad, although a long way from the 15-20 percent returns Derwent previously said it is targeting. But that performance is certainly better than that of star hedgies like John 'The Greatest Trade Ever' Paulson, who recently was down a painful 31 percent in one of his funds even before the markets went haywire last week. The obvious question for Derwent -- will it last? Any dopey algorithm can out-sprint alpha for a month. As Warren Buffett can attest, market success is measured over the long haul.
Derwent Capital, which finished its first month of trading at the end of July, beat the S&P 500, which fell 2.2 percent in July, while the average hedge fund made 0.76 percent, according to Hedge Fund Research.
The $40 million fund works by scanning 10 percent of the tweets on Twitter for hints about how users are feeling at any given time. Messages are grouped according to their general emotional content. A surge in "happy" or other upbeat tweets one day might predict an upturn in the market later in the week, with a predominance of "sad" messages signaling a bearish swing. "Calm" words were even more predictive, according to the university research on which the Derwent fund is based.
As Derwent co-owner Mark Hatwin told Bloomberg last year:
"The only risk for us is if Twitter falls away and people just don't use it any more," Hawtin said. "But we believe that it can only get bigger and better, and that more and more people will be using it to express their feelings."I see another risk. If the approach proves successful, every hedge fund, mutual fund and other stock-picking firm worth its steep management fees will soon be trotting out tweet-tuned funds. Will Derwent's trading model win out? Maybe. Or maybe its edge will vanish as others start mining Twitter and other social media nodes for sentiment clues. As a guide to the future, such data loses value once it's broadly available to the market.
Still, it's a decent start for Derwent, especially with markets convulsing in recent weeks. Let's check back in a few months to see if the firm is still chirping.
Thumbnail from Flickr user drothamel