Stock traders are constantly looking for ways to figure out what the markets are going to do so they can get an edge on everyone else some even track seemingly unrelated factors like the weather to see which way the wind is blowing when it comes to the stock market. So its probably no surprise that now traders are trying to track the giant global conversation known as Twitter in order to figure out which stocks are becoming popular. But is there any evidence that this actually works? A German PhD student says that his analysis shows it can. and he has set up a website called TweetTrader.net to put his theories to the test.

The idea behind tracking Twitter is an appealing one: if millions of people are talking about the things they like or dislike via the service whether those things are movies, books, food or celebrities then its likely that some proportion of those tweets will be about stocks. Since sentiment indicators compiled by brokerage-firm research departments and economists are a big factor in the analysis done by many professional stock traders, the theory is that tracking the comments of individual investors and other observers in real time could provide similar kinds of information.

Timm Sprenger, a doctoral student in the school of management at the Technical University of Munich, recently published a research paper called Tweets and Trades: The Information Content of Stock Microblogs , in which he looked at the predictive value of tweets that mention stocks or the overall market. Sprenger and his research partner tracked and analyzed 250,000 tweets a day over a six-month period that fit that description, using semantic analysis to try and determine whether they were positive or negative (bullish or bearish, in stock-market terms).

According to Sprengers research, the sentiment rankings that his system extracted matched the ebb and flow of the Standard & Poors 500-stock index fairly closely, and appeared to predict movements in the market by more than a day. The researchers said that any investor who bought or sold using their analysis in the first half of 2010 would have achieved an average rate of return as high as 15 percent. At TweetTrader, which Sprenger set up recently with some fellow students, investors can track the sentiment rankings of various stocks and indexes based on the systems used in his research.

Sprengers paper is just the latest study to try and establish a connection between sentiment analysis of Twitter and the movements of the stock market. Last year, researchers from the University of Manchester and Indiana University published a report that looked at the predictive value of sentiment analysis extracted from Twitter (PDF link) compared to the movements of the Dow Jones Industrial Average. The study said that its system could predict the market index with 87-percent accuracy and not long after the research was published, a hedge fund called Derwent Capital Markets announced that it was launching a fund that would trade based on these kinds of analysis.

The idea behind TweetTrader is similar to StockTwits.com, a service co-founded by entrepreneur Soren Macbeth and venture investor Howard Lindzon (see disclaimer below) as a way to track stock-related commentary and analysis. The site has progressed beyond just tracking or aggregating tweets with stock symbols, however, and has become what Lindzon calls a social Bloomberg or a Facebook for finance a social network for those interested in stocks and trading. StockTwits also runs its own platform, something it decided to do after growing dissatisfied with Twitters repeated outages.

As I pointed out in my last post on Twitter-based stock analysis. the risk with Sprengers approach is that any open system such as Twitter can be gamed by those who want to promote certain stocks, just as message boards were in the early days of web-based investing and just as Googles search results are by SEO engineers. Anyone pursuing that kind of approach to investing is going to have to take that into account.

Disclosure. StockTwits is backed by True Ventures, a venture capital firm that is an investor in the parent company of this blog, Giga Omni Media. Om Malik, founder of Giga Omni Media, is also a venture partner at True.