Review and Update of Social Media-Based Sentiment Signals
In previous research, we introduced a proprietary database of comments from the WallStreetBets sub-reddit. We used this database in two ways: to identify stocks that were seeing an uptick in mentions, and to build a proxy for sentiment around the overall market. We found that stocks seeing an uptick in mentions, coupled with an increase in trading activity, tended to underperform going forward; we called this group of stocks the Reddit Alert list. We also found that the general level of sentiment among WallStreetBets users acted as an effective contra-indicator for the market. In this note, we provide updates to the composition and performance of the Reddit Alert list and the Reddit-based sentiment indicator.
We start with our analysis of the Reddit Alert list. To review, for a stock to be added to the Reddit Alert list, it must undergo an increase in its mentions on WallStreetBets, along with a rise in trading activity around its shares or related options. As described in the initial research, stocks usually underperform the index after being added to the Reddit Alert List. Fig. 1 below shows the return (relative to the S&P 500) for the typical stock after it has been added to the Reddit Alert list. Stocks added to the Reddit Alert list typically underperform the S&P 500 by over 4% in the 21 days following their inclusion.
In Fig. 2, we show the current members of the Reddit Alert list. While some stocks added to the list have outperformed the index since their inclusion, the typical stock underperforms while it is a member of the Reddit Alert list.
In our second analysis, we built a gauge of general sentiment toward the overall market. We focused on comments that discuss the overall equity market, assigned a sentiment score to each comment, then aggregated those sentiment scores at a daily frequency to create a proxy for the retail sentiment toward the overall market. Fig. 3 shows how the sentiment proxy evolves over time.
We found that this sentiment proxy acts as an effective contra-indicator for the market; when the sentiment proxy was extremely low, indicating fear among retail investors, the market tended to rally going forward. Conversely, when the sentiment proxy was high, indicating greed among the retail crowd, the market tended to sell off.
Fig. 4 shows the subsequent 5-day return of the SPDR S&P 500 ETF Trust (ticker SPY) as a function of the sentiment proxy, focusing on instances where sentiment reaches extreme levels. In this chart, the bars show the average 5-day subsequent return for the SPY based on the current reading of the sentiment proxy. Note that when the sentiment is most negative, the market tends to see its best periods of performance.
Since our initial work in April where we revealed the sentiment proxy, it has reached extreme negative values three times, once each in May, June and July. Fig. 5 shows how the sentiment proxy has evolved since April, with the red arrows indicating the dates where the sentiment reached extreme values (on May 19th, June 21st and July 13th).
Following the instances where the sentiment proxy most recently reached low values (indicated by the arrows in Fig. 5), the SPY saw gains during the subsequent 5 trading days of 6.6%, 1.6% and 5.5%, respectively. While three data points are hardly sufficient to draw widespread conclusions, these recent observations suggest that the Reddit-based sentiment measure continues to act as an effective contra-indicator for the market.
Most recently, the sentiment measure has jumped into extreme positive territory. While the market has seen a strong rally in recent weeks, the euphoria reflected in the sentiment proxy may indicate that the rally could stall in the short-term.
In this research note, we have updated our prior work around social media-based signals. We find that stocks on our Reddit Alert list continue to underperform the market up to 21 days after being added. We also provide an update on our Reddit-based sentiment signal and show that it has continued to act as an effective contra-indicator for the market, particularly when it reached levels of extreme bearishness as it did during May, June, and July of this year.
 Alternative Data Introduction  Alternative Data: Sentiment from Social Media  Returns are computed one day after the sentiment indicator reading. For example, the 5-day return of 6.6% was measured over the period from May 20th through May 27th.