Can Google Trends help construct a winning trading strategy?

26th April 2013

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This is sure to cause some excitement among those looking for a new way to crack the secrets of the stock market. A academic paper published on Nature.com suggests that using Google Trends to analyse search terms can help predict trading behaviour and could allow investors to devise a strategy to land big returns.

Tobias Preis, Associate Professor of Behavioural Science and Finance at Warwick Business School, Doctor Suzy Moat, of University College London, and Doctor Gene Stanley, of Boston University, found that using these changes in search volume as the basis of a trading strategy investing in the Dow Jones Industrial Average Index could have led to substantial profits.

The terms used among the 98 included ‘revenue’, ‘unemployment’, ‘credit’ and ‘nasdaq’ – in Google searches from 2004 to 2011.

If the search volume that day was high compared with the previous week, the Dow Jones was sold at the closing price the following day, and then repurchased at the end of the first day of trading in the week after. If the search volume on Sunday was low compared with the previous week, the researchers “bought” the following day.

By using the keyword “debt” – the term that saw the greatest fluctuation – the strategy brought in a dramatic profit of 326pc over seven years. By comparison, a strategy of buy-and-hold – purchasing in 2004 and selling in 2011 – would have yielded only 16pc profit, equal to the rise in the index during this time.

The report says: “Our empirical results so far are consistent with a two part hypothesis: namely that key increases in the price of the Dow Jones Industrials Average were preceded by a decrease in search volume for certain financially related terms, and conversely, that key decreases in the price of the Dow Jones Industrials Average were preceded by an increase in search volume for certain financially related terms. However, our trading strategy can be decomposed into two strategy components: one in which a decrease in search volume prompts us to buy (or take a long position) and one in which an increase in search volume prompts us to sell (or take a short position).”

One reason for success may well be that investors, before they sell out at a loss, search for a lot of information first.

Five observations/questions from Mindful Money

1)  First this works in the US for two reasons – it is a highly networked market with a large number of stock market traders including many members of the public. Their behaviour is easily tracked by Google in a way that institutions’ behaviour or traders’ behaviour elsewhere around the world may not be. If would be fascinating to see how a similar study might work for the FTSE All Share or FTSE 100.

2) This is an historic survey from 2004 to 2011. Past studies of performance are not necessarily a guide to the future though actually we can see how this might work. Increasingly  measuring sentiment in this way will play a role.

3) We wonder if professional investors and fund managers will start to incorporate this information into their thinking. Is it only Google trends or can other sources of big data have a bearing? Many investors already incorporate consumer sentiment into their investment decisions. But does the advantage of such a system erode if everyone starts to get savvy to it as a predictor of market behaviour?

4) We wonder if it would be possible to devise a stock specific early warning system? Apple anyone?

5) What will be interesting to see if anyone adopts this technique either in the UK or the US and if it works. If you decide to start doing it, remember almost all the usual rules of investing apply although with a slightly different source of information.

25 thoughts on “Can Google Trends help construct a winning trading strategy?”

  1. Drf says:

    “My main regret is that UK ballot papers do not have a “none of the above” option.” Agreed 100%.

    1. Anonymous says:

      Indeed. This has been my suggestion for many years when discussing the notion of compulsory voting. Everyone should be made to vote… but not necessarily for any of the candidates.

      1. Laughing Gnome says:

        Made to vote why? What does it serve to drive idlers to the poll who’s only information comes from the Daily Mail or BBC?
        The electoral reform referendum was won by disengaged people unable to think un-aided, hence the continuing domination of the “big” 3.

        1. Anonymous says:

          and a poor question. There was not a sensible debate about alternate voting systems.

          The LDs pushed a dubious option, which they calculated would give them an advantage – in preference to everyone trying to find a better system.

          PS. You are correct about voters failing to think long term.

          1. Anonymous says:

            “Made to vote” because along with paying taxes &Jury service it should be a public duty to turn up and have a say in order to further legitimise government.
            Obviously under the current electoral system in the UK the results would be much the same anyway but with the introduction of some form of PR then a real difference could be made.
            Lauging Gnome – with your obvious bias against certain media outlets I can understand why you wouldn’t want everyone to have a say. Presumably then, you would rather those people weren’t allowed to vote at all? Hardly democratic though , is it?

          2. Laughing Gnome says:

            Ha, I do struggle to resist that notion WhiteP :-) Why would you want our government “further legitimised” pray? FYI, there are more concepts of “democracy” than putting the mark of an illiterate next to the name of a stranger every five years.

          3. Anonymous says:

            Totally agree that there are probably better ways to express “democracy” than our current fantasy. But I have to throw the question back you… Why on earth would you NOT want a legitimate government? I didn’t say I want a continuation of the current state of affairs but in any democracy the governing body has to be thought of as legitimate surely?

          4. Laughing Gnome says:

            Right enough WhiteP. I tend to be flippant because the current charade makes me so angry. Many people declare themselves “not interested in politics”. It doesn’t seem to stop them doing their democratic duty though! Seriously – power should be devolved to the lowest level appropriate to function in order that we are each affected as little as possible by the decisions of the mob.

          5. therrawbuzzin says:

            Legitimise their chicanery, corruption and jiggery-pokery?
            I have a better idea: in 1979 the Scottish referendum on devolution was subject to a minimum 40% of those able to vote.
            How about a similar system for constituencies, whereby if no-one gets 40% of the AVAILABLE votes, that constituency does not return an MP?
            Then all could at least claim something of a genuine mandate of their electorate.

          6. Anonymous says:

            Proportional representation fails on party lists – in dodgy countries, positions are bought – ref: oligarchy.

            First past the post fails to represent the majority, Eg a commons majority with 35% of the vote. When I lived in Willesden my vote was worthless – labour win certain. Likewise when I lived near the Aldershot/Wokingham electorate boundary, a tory win was certain. Disenfranchised from democracy.

            Hence I think decision by referendum is a better answer – my vote will be fairly counted.

          7. Laughing Gnome says:

            Well I had wanted the majoritarian system proposed for half my days. Gutted! One could debate various systems for years; my big reservation is over systems that establish a party vote rather than for an individual. The very best and by far the simplest i.m.o. is a system of my own invention for which I don’t yet have a name. BTW; failing to think, period :-)

          8. Anonymous says:

            Switzerland have the best democracy. They use referendums – leaving lobbyists to play public opinion, not bribe politicians.

  2. anteos says:

    great article as always Shaun.

    you’ve got to hand it to the gment propaganda department. To convince the majority of the population that they’re carrying out austerity. when in fact….

    For the financial year 2013/14, central government accrued current expenditure was £640.1 billion, which was £9.0 billion, or 1.4%, higher than the same period the previous year

    someone is going to get a very big surprise after the next election.

    1. Anonymous says:

      Hi Anteos and thank you

      As to the numbers for 2013/14 you are entirely right so there was a cut in real terms if we use CPI of ~1%. I am using CPI because after all it is them who argue it is a better measure!

      It does not go with the austerity headlines does it? And yet we know that people have been affected by it so who has gained?

  3. Anonymous says:

    Shaun,
    Any indication on where HMG expenditure is increasing? Is self employment “carrots” replacing unemployment benefits?
    Also Colleges as ATMs also surfacing on student fees/loans
    ref:
    http://www.theguardian.com/education/2014/may/21/london-college-funding-students-cannot-learn
    (now learnt lesson of providing sources!)

    1. Anonymous says:

      Hi Chris

      Thanks for the link which is a rather worrying development is it not?

      In terms of expenditure details we only get broad brush strokes from this data for example these are the changes for the last fiscal year

      “Within this, net social benefit expenditure (largely pension benefits), was £193.4 billion (an increase of £1.9 billion, or 1.0%) and other current expenditure (predominantly departmental expenditure) was £398.8 billion (an increase of £6.7 billion, or 1.7%).”

      So as far as we can tell it is on something the government is choosing to spend on rather than being forced like pensions or the Job Seekers Allowance.

      What self-employment carrots are you thinking of?

  4. therrawbuzzin says:

    With the de facto divorce between bank rates and credit prices, would raising them do anything other than hurt our lords and masters (the banks)?

    1. Anonymous says:

      Hi therrawbuzzin

      If you go back 3 years or so on here I was making that case. Higher base rates were needed to respond to likely rising inflation ( I was proven right as it of course went above 5%) and I added to it the rider that if in a position to do so (MPC) I would also press for restrictions on how the banks could pass this on.

      I do not write about it that often as base rates are not the 1.5%/2% I would have put them too.However if you look at what the inflation which the Bank of England ignored did to real wages we would be in better shape now as an economy.

  5. GusBmth says:

    Hello Shaun

    Thanks for another great post.

    Re the base rate, I keep reading that ‘experts’ believe the most likely time for a move is in Spring next year – but surely that is the least likely time? Are people seriously believing that a (supposedly) independent central bank would increase the base rate for the first time in many years just ahead of a General Election? – An election which is highly likely to be very close run.
    I think that the BofE would avoid making any move within a 3 month window of the election, so that the most likely timing of any Base Rate rise would be 4Q this year or 2Q next year, with the possibility of a Feb move if Xmas retail sales were very strong.

    Your point about a rising deficit at a time of strong growth is spot on. Do you know if alarm bells are ringing in the Treasury, as these disappointing numbers are becoming a firmly established trend?

    1. Anonymous says:

      Hi Gus

      I agree about your timing point and can only say that if I was on the MPC I would try to make only unavoidable moves in an election campaign. The investor Paul Tudor Jones was presumably thinking along those lines when in a speech last week he said that he thought the UK would raise interest-rates 1st and it would be around December time in his opinion.

      If HM Treasury is not worried then it should be. However there is one caveat which is that they are doing this deliberately….

  6. JW says:

    Hi Shaun
    Good piece, read early enough to comment.
    The BoE busily monetises debt by rolling over and eventually retiring debt, the government spends it, and asset prices, especially property roar ahead. People continue to believe they are more wealthy and spend and get into personal debt. The official statistics appear to show recovery and growth. What’s not to like? Continual debasement of the fiat in your pocket, not against other fiats, because they are all going the same way in unison. It shows up in the intangibles of life, the quality of life. tHe vast majority are over-worked and over-stressed , its as a result of deliberate policies.

    1. Anonymous says:

      Hi JW

      It is obvious that many if not most economic theories and models either have or are failing. I think that where they went wrong about issues like QE is that it was looked at in isolation for a single country rather than it being used in so many places.

      As to the overworked and stressed theme I think that it is one of the factors behind the rise of self-employment. As well as those forced into it I think that some are sick of the compromises of employed work.

  7. Noo 2 Economics says:

    Hi Shaun,

    Best move now is as you say stop rolling over QE and I think there may be a light at the end of the dark tunnel that is the housing market in the form of the Mortgage Market Review requiring Banks to start lending money that people can actually afford to repay on assumptions of, I think, 6% rates alongside examinations of lifestyle.

    If it’s implemented properly there should be a boom in mortgage application refusals thus starting to cool down the market, except London that is, which is it’s own “country” flooded with foreign cash buyers. Maybe the way round that is 10 times council tax to to be paid on empty properties and see how much of a “sure thing” investors think London property is then.

    1. Paul C says:

      Hi Noo2, I love the idea of taxing empty properties or under occupied but how to establish genuine occupation?

  8. therrawbuzzin says:

    From elsewhere, a thought which intrigued me:

    “When the cost & availability of borrowing to the construction industry is
    largely at the discretion of the same institutions (banks) who’s viability &
    very existence now depends on house prices not falling, is there not at the very least a conflict of interest?”

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