This mathematician has found a way to make money off how investors think

Disagreement on social media investing forums can be a good indicator of where to invest, a Monash mathematician has found.

Dr Hasan Fallahgoul, a mathematician at the Monash University School of Mathematics Centre for Quantitative Finance and Investment Strategies, says an arbitrage system can be worked out using investor sentiment and price movements.

Dr Fallahgoul analysed almost 3.7 million messages posted to the StockTwits platform, which lets users tag their posts with sentiment, between November 30, 2019, and March 31, 2020 to get inside the minds of investors.

He found that the ‘disagreement’ between bulls and bears reached an extreme level on March 23, the day the market bottomed.

“If I want to invest based on the relationship between the disagreement and price process on March 23, I would take long positions in stocks that just had the highest disagreement,” Dr Fallahgoul said.

The same strategy can be used for sectors by taking a short position in an exchange traded fund (ETF) if the disagreement is low, and a long position if it’s high.

In March, disagreement was high around financials and low among healthcare stocks.

The end of Afterpay (ASX:APT) was widely called during and after the depths of the March rout, and yet it’s up 518 per cent from those lows. Bank stocks have also come back in the last two weeks.

In contrast, the biggest three health stocks are only up 5-20 per cent from their March lows.

Technical analysis

Picking sentiment seems a little like picking the bottom of a stock: impossible.

Dr Fallahgoul averaged out sentiment over time using a simple moving average approach, on the basis that the sentiment of a user is unlikely to change instantaneously and more likely to move gradually.

“Investors often use [a] moving average approach to detect a signal for taking long or short positions, trend-following approach,” he wrote in his paper on the subject.

He found technical investors were more likely to post bullish messages.

“There are several unexplored and exciting directions for further investigation of social media platforms such as the StockTwits dataset,” Dr Fallahgoul said.

“For example, John Maynard Keynes claims that when there is too much activity in the market, such as during a crisis, investors and agents trade mostly by looking at each other’s strategies rather than information.

“The study found that professional investors were more pessimistic, and posted more often on StockTwits, than novice and intermediate investors.”

Trading mania

The mania for investing was noted by corporate cop ASIC, which said in May there had been a massive surge of new amateur traders into ASX investing.

Most did not cover themselves in glory, with the majority buying when a stock was high and selling when it was low.

Wealth Within chief analyst Dale Gilham called amateur investors “more like children diving their hands into a lucky dip hoping they will get something good”.

He says the market volatility proved that many investors, old and young, did not follow good rules for building a portfolio and did not have a strategy.