1. | © Copyright 2008 Dow Jones and Company Trading Off the News: Applications of News Algorithms July 1, 2008CARISMA 2008 Alan Slomowitz Director Product Development Algorithmic and Trading Solutions Dow Jones Content Technology Solutions

2. | © Copyright 2008 Dow Jones and Company Source: DJ Newswires Trading Off The News - HP to Acquire EDS 15:02 *WSJ: Hewlett-Packard In Advanced Talks to Acquire EDS 15:02 *WSJ: Hewlett-Packard-EDS Deal Could Come In Matter Of Days 15:03 *WSJ: Premium Expected To Be In 30% Range –Sources 15:03 *WSJ: EDS Overall Price Roughly $13 Billion -Sources >HPQ EDS

3. | © Copyright 2008 Dow Jones and Company 3  Successful trading is about finding the crucial edge  First to take advantage of trading opportunities  Quantitative investors require:  Analytical hypotheses  Technology  Data  Data = News  Exploit this new information source  Difficult-to-quantify qualitative content News and the Quantitative Investor: The New Frontier

4. | © Copyright 2008 Dow Jones and Company 4  Intuitively, investment professionals realize you can use news to create profitable trading models  Proprietary traders, Stat Arb desks and hedge funds now use news to create Alpha-based trading strategies  News based algorithms that can profit from market anomalies lasting from mere milliseconds to days or even longer  Economic indicator based algorithms  Corporate news based algorithms  News-based algorithms are valuable additions to Alpha generation:  News is difficult to integrate into investment models  Difficulty means higher value – not so easy to commoditize  Requires different tools – both data and text analysis tools  Different ways of analyzing market trends Taking Advantage of the News

5. | © Copyright 2008 Dow Jones and Company  Economic Indicator-Based Algorithms  Arms Race – Must have a global, reliable and innovative news provider  Latency matters  FX and Futures markets  Multiple markets and countries  Corporate News-Based Algorithms  Scheduled events: Earnings, Guidance  Unscheduled events: Mergers, Ratings changes, Executive changes  Text mining events: surprise and sentiment  Analyzing the language of the news  Quantifying that analysis Making News Work for You: Tagged, Machine-Readable News Feed

6. | © Copyright 2008 Dow Jones and Company  Expected Corporate News Events  Plan for releases incorporating expected, historical and actual data  How long does it take for market to assimilate this news  Unexpected News Events  Cannot build an alpha algorithm for every unexpected event  Anticipate a controlled set of pre-defined news events  Ratings changes, executive changes, dividends  Capability to stop algorithms that are in flight when such news events occur  e.g., HP announces purchase of EDS  Adjust trading strategy for significant events Solving the Corporate News Puzzle

7. | © Copyright 2008 Dow Jones and Company  Complex Event Processing  Multiple signals combined  If EPS > X and Price moves > 3% in 5 minutes and market is up less than 1% Then BUY XXXX shares  Academic Research Solving the Corporate News Puzzle (cont.)

8. | © Copyright 2008 Dow Jones and Company 8  Paul Tetlock, Quantifying Language to Measure Firms’ Fundamentals (Sept 2006/May 2007)  Linguistic media content captures otherwise hard-to-quantify aspects of firms’ fundamentals, which investors quickly factor into stock prices  Simple counting of negative words can uncover negative sentiment in earnings releases  Antweiler and Frank, Do U.S. Stock Markets Typically Overreact to Corporate News Stories? (October, 2005)  Initial returns jump is typically accompanied by a temporary jump in trading volume  Reversal is typically accompanied by gradually declining trading volume  During business cycle expansions, the process is largely complete after two or three weeks  During recessions, the reversal is much more prolonged and we are not able to identify a clear point at which the process ends What the Academics are Saying

9. | © Copyright 2008 Dow Jones and Company 9  Paul Tetlock, Giving Content to Investor Sentiment: The Role of Media in the Stock Market, Journal of Finance (June 2007)  Academic Bibliography available What the Academics are Saying (cont.)

10. | © Copyright 2008 Dow Jones and Company Long/Short Portfolio Firms with positive news – Long Firms with negative news – Short Hold for one trading day Rebalance at end of next trading day Trading off Positive/Negative Word Counts More Than Words – Quantifying Language to Measure Firms’ Fundamentals May 2007 – Tetlock, Saar-Tsechansky, Macskassy

11. | © Copyright 2008 Dow Jones and Company S&P 500 Firms All news stories with a fraction of negative words in the year’s top (bottom) quartile as negative (positive) stories Compute difference between reaction to positive and negative news stories Abnormal Event Returns 10 Days Prior and 10 Days Post News Releases More Than Words – Quantifying Language to Measure Firms’ Fundamentals May 2007 – Tetlock, Saar-Tsechansky, Macskassy

12. | © Copyright 2008 Dow Jones and Company Cumulative SUE 10 quarters prior to news and 10 quarters after news Negative stories 30 days prior to earnings announcements Cumulative Standardized Unexpected Earnings (SUE) More Than Words – Quantifying Language to Measure Firms’ Fundamentals May 2007 – Tetlock, Saar-Tsechansky, Macskassy

13. | © Copyright 2008 Dow Jones and Company 40 Minutes of Alpha Research in Progress S&P 500 Companies Beat the estimates and you are king … Miss your estimates and you get hammered … For 40 Minutes!

14. | © Copyright 2008 Dow Jones and Company  Rapidly changing market conditions and news events alter market prices and expectations  Belief is that prices should fully reflect expectations  News events do have significant effects on market prices and returns  Merger announcements  Earnings guidance  Interest-rate cuts News Impacts: Some Examples

15. | © Copyright 2008 Dow Jones and Company Bank of America to Buy Countrywide

16. | © Copyright 2008 Dow Jones and Company Source: DJ Newswires & MarketWatch GE Earnings Guidance

17. | © Copyright 2008 Dow Jones and Company Bank of England Cuts Rates * DJ Bank of England Cuts Bank Rate To 5.25% From 5.5%

18. | © Copyright 2008 Dow Jones and Company 18  The Ultimate Challenge: Deriving tradable meaning from the news  Start with publicly available content like DJ News, press releases, EDGAR filings  Determine analytical methodology  Back-test and determine viability  Integrate multiple models, sources  Apply to real-world  Requirements  Large archive  Text mining tools  Sentiment models  Skilled analysts Good News/Bad News – Profit from Both

19. | © Copyright 2008 Dow Jones and Company 19  Profiting from expected events  Economic data changes  News and momentum:  Evidence that news gives rise to long- and short-term momentum in prices  Overreaction and underreaction:  On news releases, stocks overshoot with prices misaligned with fundamentals  Sentiment - Count of negative news:  A simple count of negative words in news has proven to provide strategies with positive Alpha Potential Alphas

20. | © Copyright 2008 Dow Jones and Company Profiting From News Has Its Challenges  What news events to capture  Economic data, Earnings, Guidance – the easy stuff  Mergers & acquisitions, executive changes, bankruptcies – that’s tough  Sentiment - ??  Many news feeds are not tagged or machine-readable  Need to parse, automate, and digest news  Web-based content is another major challenge  Need to determine:  Which news is relevant? So many sources!  How to react to unexpected events?  Trusted sources  Is news already factored into price?  Which direction will news push the price?

21. | © Copyright 2008 Dow Jones and Company Final Thoughts  Electronic and Quantitative Trading market is rapidly evolving  News is an increasingly important driver of automated trading strategies  Growing number of tradable news events  News data algorithms  Economic data; earnings and guidance  Elementized News events  Ratings changes, mergers & acquisitions, executive changes  Trading on planned events is profitable  If you can react quickly enough  Not paying attention to news can cost you  Lost Alpha opportunities  Outright losses

22. | © Copyright 2008 Dow Jones and Company  Suite of advanced information and technology tools for a performance edge  Unique news data, tagged and elementized  Computer-readable  Flexible, ultra-low-latency delivery options and seamless integration  News sentiment tools  20-plus-year news archives for back-testing ideas  Tools for creating, deploying and adapting complex, news-based trading strategies  Products  Dow Jones Elementized News Feed  Economic Data – Major economic indicators  Corporate Data – Earnings, Guidance, Mergers, Executive Changes, Ratings, Bankruptcies, more  Dow Jones News & Archives for Algorithmic Applications  20-plus-year archive of news for analysis  Viewer and toolkit available  Dow Jones News Analytics  News transformed into actionable data  Derive analytics based on sentiment, volume, more Transforming News For Quantitative Trading And Research Dow Jones Solutions For Algorithmic & Quantitative Trading

23. | © Copyright 2008 Dow Jones and Company 23 Questions? Trading Off The News

24. | © Copyright 2008 Dow Jones and Company Trading Off The News: Applications Of News Algorithms Alan Slomowitz: alan.slomowitz@dowjones.comalan.slomowitz@dowjones.com (201) 938-2195