In the fast-paced world of finance, staying ahead of the curve is essential. For years, investors have relied on traditional data sources like company filings, analyst reports, and economic indicators to make informed decisions. However, in recent years, a new type of data has emerged that is changing the way we understand and invest in markets: alternative data.
Alternative data encompasses information derived from unconventional sources, extending beyond the confines of traditional financial data. This diverse array covers a vast spectrum, encompassing social media activity, satellite imagery, credit card transactions, web traffic patterns, and other unconventional sources.
While often unstructured and intricate, this data holds immense potential for unlocking valuable insights into consumer behavior, company performance, and broader market trends. Interestingly, this blog post will help you understand alternative data and why it is changing finance.
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What is Alternative Data?
Alternative data refers to data sets gathered from unconventional sources. For investors, this could mean looking beyond company filings alongside what brokers say to gain an edge in the market.
Some examples of alternative data are satellite imagery, product reviews, credit card transactions, and social media commentary. These kinds of things can help to build up trading ideas and contain information that can move share prices.
Who Uses Alternative Data?
When alternative data began in the mid-2000s, it was primarily used by hedge funds. During that time, it was very expensive and could only be afforded by wealthy traders seeking to make quick moves and profits.
However presently, alternative data is commonly used by all types of investment firms. Its major users are quants or algorithmic traders who use the data to build computer models for trading equities. But long-term, buy-and-hold investors are also acquiring positions based on alternative data findings.
Furthermore, industry insiders have said that organizations are often basing corporate decisions on the information obtained from alternative data. They also assert that private equity companies tap into this data when striking deals and sizing up targets.
Examples of Alternative Data
If insightful information about a company comes from non-traditional sources, it is considered alternative data. However, many things fall into this category. Some of the most common ones include the following:
1. Satellite Imagery
There are numerous uses for taking pictures of planet Earth from orbit. When it comes to investment, it may be used to track supply chain issues such as natural disasters and construction projects, as well as evaluate the health of oil fields and how many cars are parked in store lots.
2. Social Sentiment and Product Reviews
The internet is a great place to find out what the general public thinks about companies that are listed on stock exchanges. Likes, comments, and reviews are powerful and can serve as a predictor of future sales. They also provide a picture of the opinions of paying consumers regarding the products or services provided.
3. Jet Tracking
It can be quite profitable to follow some people’s whereabouts. Share prices can be greatly affected by takeovers, private equity transactions, and high-profile investors purchasing shares in companies. These events can often be predicted in advance by monitoring corporate aviation movements.
4. Internet of Things
Not only does internet connectivity improve product efficiency, but it may also benefit investors. Once they are connected to the internet, the data gathered is stored and shared. However, this data will not all be useful. But, some parts might turn out to be quite informative and profitable for people who know about them.
Why is Alternative Data Changing Finance?
There are several reasons alternative data is changing finance. And we’ll explore a few of them below.
Access to new insights: Alternative data sets can provide access to new insights that are unavailable from traditional data sources. For instance, an investor could use social media data to gauge consumer sentiment towards a particular company or product. You can use this information to make informed decisions about whether to buy or sell a stock.
Personalization of Financial Products and Services: It can be used to create personalized financial products and services. For instance, a bank could use social media information to offer a personalized financial advice service. This service could also be used to provide recommendations on investment strategies, retirement planning, and other financial matters.
Enhanced Risk Management: Alternative data sets provide a more comprehensive understanding of risks faced by companies and markets. This information can be used to develop better risk management strategies and make informed decisions about whether to invest in certain sectors or industries.
Improved decision-making: This information can help investors make better decisions by providing them with a more complete picture of a company or market. An investor could use satellite imagery to track the movement of goods and materials, which could be used to predict changes in demand for a particular commodity. So, you can use this information to make informed decisions about whether to buy or sell a commodity futures contract.
Increased returns: Alternative data sets can help investors generate higher returns by identifying undervalued or overvalued companies. Thus, an investor could use credit card transaction data to assess the creditworthiness of a company or its customers. This, in turn, can be used to make informed decisions about whether to buy or sell a corporate bond.
Read also: Is Finance a Good Career Path?
How is Alternative Data Collected And Distributed?
Alternative data is obtained from different sources such as mobile devices, financial transactions, sensors, the internet, satellites, and public records. However, the raw data is collected using technology developed by specialist providers.
Afterward, the findings are jointly evaluated by humans and technology before being packaged for consumption. Presently, several companies specialize in alternative data. Some concentrate on private jet movements or social media while others provide more complete packages.
Disadvantages of Alternative Data
If used rightly, alternative data sets can be lucrative. But that doesn’t mean it’s flawless. Additionally, it should only be followed up on after other analyses including careful due diligence.
Meanwhile, one major disadvantage is the risk that the data is not entirely representative and it tells only part of a story. As technology improves, it may be incapable of detecting everything and might overlook some essential information.
Other notable drawbacks of this type of data include the fact that it is obtained by invading privacy and that it can require some time for interesting findings to reach the mainstream and affect share prices.
The use of alternative data is still in its early stages of development, but it has the potential to revolutionize the way we invest and manage risk. As the volume and quality of alternative data increases, it is likely to play an even greater role in the future of finance.