Leveraging Social Media Sentiment for Predictive Algorithmic Trading Strategies

TL;DR

This paper demonstrates that Reddit comment sentiment and volume data can be effectively used to predict short-term stock movements and develop trading strategies that outperform traditional buy-and-hold approaches.

Contribution

It introduces the Sentiment Volume Change (SVC) metric combining sentiment and comment volume, showing its effectiveness in investment decision-making.

Findings

SVC correlates strongly with next-day returns.

Strategies based on SVC outperform buy-and-hold in bull markets.

Reddit sentiment data improves risk-adjusted returns.

Abstract

This study investigates how social media sentiment derived from Reddit comments can be used to enhance investment decisions in a way that offers higher returns with lower risk. Using BERTweet we analyzed over 2 million Reddit comments from the subreddit r/wallstreetbets and developed a Sentiment Volume Change (SVC) metric combining sentiment and comment volume changes, which showed significantly improved correlation with next-day returns compared to sentiment alone. We then implemented two different investment strategies that relied solely on SVC to make decisions. Back testing these strategies over four years (2020-2023) our strategies significantly outperformed a comparable buy-and-hold (B&H) strategy in a bull market, achieving 70% higher returns in 2023 and 84.4% higher returns in 2021 while also mitigating losses by 4% in a declining market in 2022. Our results confirm that comment sentiment and volume data derived from Reddit can be effective in predicting short-term stock price movements and sentiment-powered strategies can offer superior risk-adjusted returns as compared to the market, implying that social media sentiment can potentially be a valuable investment tool.