Pricing stocks with yardsticks and sentiments

TL;DR

This paper proposes a novel stock pricing approach based on heuristics using yardsticks from index performance and sentiment analysis, supported by empirical data from the Dow Jones Industrial Average.

Contribution

It introduces a new heuristic-based method for stock valuation using index comparisons and sentiment indicators, validated with empirical Dow Jones data.

Findings

Stocks tend to cluster around yardstick measures daily.

Market sentiment influences stock performance over months and years.

Sentiment effects may be driven by insider information.

Abstract

Human decision making by professionals trading daily in the stock market can be a daunting task. It includes decisions on whether to keep on investing or to exit a market subject to huge price swings, and how to price in news or rumors attributed to a specific stock. The question then arises how professional traders, who specialize in daily buying and selling large amounts of a given stock, know how to properly price a given stock on a given day? Here we introduce the idea that people use heuristics, or "rules of thumb", in terms of "yard sticks" from the performance of the other stocks in a stock index. The under- /over-performance with respect to such a yard stick then signifies a general negative/positive sentiment of the market participants towards a given stock. Using empirical data of the Dow Jones Industrial Average, stocks are shown to have daily performances with a clear tendency to cluster around the measures introduced by the yard sticks. We illustrate how sentiments, most likely due to insider information, can influence the performance of a given stock over period of months, and in one case years.