How NLP is helping quant investors cut through the noise
The ‘mind-reading’ powers of NLP (natural language processing) is proving to be a valuable addition to the strategic toolkit of the quant investment industry.
NLP in its most basic form is a way for a computer to understand human language.
But it now goes far beyond that into sentiment analysis, enabling firms to determine the emotional value of communications.
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In the past this was limited to text analysis.
It was used to analyse company financial disclosures or financial statements released by the FCA (Financial Conduct Authority) or the SEC (US Securities and Exchange Commission).
Being able to detect warning signs in financial reports or the true expectations of future performance from management teams is a powerful skill for the quant investor.
Today, NLP can also be applied to audio and video.
Sentiment analysis can now be extracted from more than the printed word to measure the emotion of different words. Facial analysis and even vocal signals, such as sarcasm, can be interpreted by emotional AI.
Transcripts of earnings conference calls, speeches by analysts, TV interviews with CEOs newspaper reports, and central bank speeches can all be mined.
Outside investing, too, there are many examples of NLP sentiment analysis. The Obama administration used sentiment analysis to gauge social media sentiments for its swing state election candidates. The World Health Organization employed it as part of its research for its Vaccine Confidence Project, analysing social media, news and other platforms.
NLP now allows vast amounts of abstruse non-numeric unstructured data to be systematically harvested and analysed at breakneck speeds.
The result is that quant traders are now able to work with data scientists to use NLP to cut through the noise and glean tradable signals.
Many sophisticated quantitative investors who use algorithms to systematically trade are already tapping into NLP and building it into their investment strategies.
They’re using it in a similar way to how they are monitoring ESG events surrounding companies, products or individuals to get ahead of the curve and manage corporate and investment risk.
The Deloitte Center for Financial Services’ 2020 survey of investment management firms showed that already more than half of investment managers surveyed were planning to implement NLP technologies in 2021.
Are we at the beginning of an NLP investing revolution?
Time will tell, but NLP is, at the very least, undoubtedly empowering firms to improve their existing decision-making algorithms and develop new ones.