Tuesday, March 24, 2009

Twitter as a Daytrading Analyst

If you were to observe hedge fund portfolio managers at work, you'd notice that they interact frequently with one or more analysts and assistants. The role of the analysts is to help generate ideas for trading and investment. For example, a single portfolio manager specializing in equities might work with a number of analysts, each of whom is devoted to a particular sector. The analysts scour financial statements, talk with brokers, visit companies, and read everything they can about companies in order to generate recommendations for buying or selling. It is then up to the portfolio manager to figure out how (and whether) to incorporate that recommendation in the portfolio, when precisely to buy and sell it, when to scale into and out of the position, etc. Very often, the analysts will generate research reports that summarize their recommendations and make the case for why the idea should be expressed in the portfolio.

Active traders make buy and sell decisions on a very different basis. They are primarily looking at short-term price and volume action, news event catalysts, and other immediate data. Much of their skill consists of an ability to immerse themselves in the flow of markets and detect shifts in supply and demand. Talking with analysts--and certainly reading research reports--during the day would take them out of this flow and disrupt their work.

Nonetheless, active traders could benefit greatly from the right kind of analyst input. A common problem among daytraders is that they are so immersed in the order flow for their particular stocks or futures contracts that they miss what is happening in the wider market. For example, a leading sector could be breaking out to the upside, but a trader focused on each tick in the stock index futures could miss that altogether. That information could aid decision support for the trader. Note that, unlike in the portfolio management setting, the role of the daytrading analyst would *not* be to recommend particular trades. Rather, it would be to provide information to the trader that could be utilized in making new trades and managing existing ones.

A major challenge for the daytrading analyst is to present only the most relevant information in a format that is minimally distracting. Squwak boxes attempt this by presenting information in an auditory channel, where it will not distract a trader watching the screen. This can also be a liability, however, as the message is lost once it's delivered.

Instant messaging may be more promising as a means for conveying decision support to a trader, while taking up minimal real estate on the screen. The Twitter application, which limits each message to 140 characters, may be ideal for this purpose. The idea would be to use messages selectively to provide valuable information to a trader that the trader could not easily obtain for himself or herself. For example, a "tweet" might summarize a significant historical trading pattern or highlight an important shift in a market indicator or stock sector.

A fighter pilot typically relies on a co-pilot to monitor those things that would take the pilot's eye off what he is doing. When a job demands intense concentration and quick reflexes--such as the work of a surgeon--there is a need for helpers who can perform all the peripheral tasks and monitor a variety of conditions in real time (surgical nurses, anesthesiologists, etc.).

Ultimately, the role of a daytrading analyst is to expand the cognitive bandwidth of active traders: help them see and process more than they could on their own. The analyst does not substitute for the trader's judgment, but supports it. Think of the vast array of CIA analysts that support a single intelligence officer in the field or the scores of military analysts that support a battalion commander. All of us have limited mental bandwidth; the key is to use teamwork to make high quality decisions that no individual could achieve on his or her own.

The beauty of Twitter as a vehicle for a daytrading analyst is that it is totally scalable. The work that would go into supporting one trader could assist thousands. This means that a trader who normally could never afford to hire an individual analyst could easily subscribe to an analytical service.

Keep an eye on my intraday Twitter posts (subscription is free via RSS; the last five tweets appear on the blog page). Gradually, I will be shifting in the direction of creating what I believe to be the first dedicated analyst service for active traders. You will see updates of unique indicators and data, and blog posts will explain how to utilize this information. The first tool will be an advance-decline indicator based upon the 40 stocks in my basket (five highly weighted issues from eight S&P 500 sectors) and measuring, in real time, advances vs. declines from the market open (not from the prior day's close). My next post will explain why such a tool is valuable.