Can Google predict the market? Research offers clues

Money can be made trading equity indexes when online searches ebb and flow

By Jeff Benjamin

Apr 25, 2013 @ 12:01 am (Updated 7:54 am) EST

Bloomberg

Investing based on the volume of Internet search engine traffic on Google might not be the place for safe money, but it turns out that there is some investment value to be gleaned from tracking the online activity of the masses.

“Online resources can be used to say something about investor behavior,” said Tobias Preis, associate professor of behavioral science and finance at Warwick Business School in the United Kingdom.

Real money can be made by simply buying or selling equity market indexes when online searches for certain financial terms ebb and flow, according to a new research paper that he co-wrote, titled “Quantifying Trading Behavior in Financial Markets.”

The formula was back-tested on the Dow Jones Industrial Average for the period from January 2004 through February 2011 and found that going long or short the benchmark based on Internet searches for the word “debt” would have generated a 326% cumulative return.

By comparison, just holding the Dow industrials over that same period would have produced a 16% cumulative return.

The searches, which were all tracked using Google Trends, looked at the total number of weekly searches.

Regardless of how many searches were made, if the total weekly number was down from the previous week, it was considered a bullish indicator and the Dow industrials would be purchased and held for the upcoming week.

If the number of searches for the word “debt” increased during the week, the index would be sold short and held for the upcoming week.

The findings represent both a potential investment strategy and an example of behavioral finance, Mr. Preis said.

The index is sold short because “we take the increased search activity as a sign of concern,” he said.

“It is a general feature of human behavior that it is more complicated to sell a stock that you already own,” Mr. Preis said.

His co-authors are Helen Susannah Moat, a senior research fellow at the University College London, and H. Eugene Stanley, a professor of physics at Boston University.

The research builds on a 2010 study by Mr. Preis that tracked the stock performance of individual companies in relation to online search activity.

There is a certain logic behind the idea of doing more research before selling than before buying an investment, said Beverly Flaxington, principal at The Collaborative, which provides business advice to financial planning firms.

“It is a general human tendency that to sell will take a lot more competence because the mindset is that once we own it, we own it,” she said. “From an adviser's perspective, I'd say it's important to be aware of these kinds of trends and to do your own research on online search activity.”

The emotional challenge of selling, especially at a loss, is significant even for professional money managers, said Kent Croft, chief investment officer at Croft Funds.

“Selling at a loss is actually admitting you made a mistake and were wrong about something, and that goes against human emotions because people don't like to admit they were wrong,” he said. “As a professional, you try to make more rational and non-emotional decisions that are based on the numbers, but we know that people will sometimes postpone the decision to sell even if it can give them a loss that they can take advantage of for tax purposes.”