When making trading decisions, the sentiment may indicate a powerful momentum
shift that is about to materialize in the trading market.
When making investment decisions, the sentiment may indicate potential moves that
could affect the stock price valuation for the long term.
It is very unlikely that the sentiment could be used as the sole variable in making a
trading or an investment decision. Pragmatically, an estimate of potential stock price
movement should be considered for either trading or investment purposes.
For material news to be absorbed into stock price valuation, it is very unlikely that the
market could evaluate the true impact within the first day of the news release. Even so,
stock prices react to material news in a very significant manner. On the day of the news
release, it is not unusual for average trading volume to grow to more than double the
average daily volume and for the stock to move significant percentage points up or
down.
As such, that kind of trading activity is very likely to become news by itself which may
help to accelerate stock price movement.
4.16 News sentiment systems
As the 2006 Online News research of the Pew Internet and American Life Project shows,
‘‘when news is online it comes to the public rapidly and in larger amounts than ever
before. Today, over 65 million Americans go online to receive critical investment news
and information.’’
In addition, the regulatory environment of the US financial markets is complex and
constantly changing. That fact makes it very difficult for an individual to process the
material information available in news reports in a timely manner.
In today’s environment, with millions of traders and investors online receiving critical
news in real time, the old formulas used for valuing stock prices need serious revisions to
incorporate news sentiment as a critical variable.
News sentiment systems help to fill the gap in current stock price valuation formulas,
because they can help to determine the extent of the valuation multiple allocated to a
particular future earnings per share value to be reflected in the stock price.
As we have seen, not all news is created equal and there isn’t an easy way to rapidly
evaluate the impact that a particular piece of news may have on a stock price, especially
when you add to that the complexity of the legal environment. For instance, based on
regulation FD stipulations, it is not very clear if trading on a rumor posted on a website
or in a more traditional news media article would not be perceived as insider trading.
Therefore, to add value, news sentiment systems need to help individual traders and
investors not only assess the impact that the sentiment of a particular news piece may
have on a stock price, but also to make sure that taking advantage of such information
received in a timely manner abides by current laws.
From a functional point of view, there is a need to understand what a news sentiment
system can and cannot accomplish.
The main function of a news sentiment system is to indicate whether a particular news
item is positive or negative, as it relates to a publicly traded company. This sounds like
an easy task to accomplish and there have been multiple attempts at doing it. However, a
118 Quantifying news: Alternative metrics