Like any of the approach in the market be it indicators based, chart pattern based, candlestick based, fundamental analysis based approach. Every approach has it’s limitations along with strengths. Some of the limitations of sentiment analysis are as follows:
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Short Validity
Market sentiments always have short validity. However there is a nuance to it! Short term may vary for an intraday trader vs swing trader holding positions across days to weeks. For an intraday trader short term would refer to few minutes to max couple of hours. Similarly for positional trader validity of sentiments would be few days. In comparison to other indicators, Sentiment Analysis still gives forward looking view! Hence it is a reliable leading indicator but with shorter validity. Hence it requires continuous monitoring validity period to validity period.
Data Quality
Another important limitation of sentiment analysis is if the quality of data is poor then there are good chances for sentiment analysis to give incorrect sentiments. Since it’s an algorithm driven, hence if garbage in then garbage out! Hence it becomes very important to ensure high quality of data feed.
High Maintenance
Unlike other indicators, sentiment analysis requires consistent processing of input data, where input data may vary from number feeds from a series to textual data without any structure in place and possibility of restructuring of data. Hence it requires continuous maintenance of input data feed as well as algorithm to continuously churn sentiment insights on a stock or an index etc.
Lack of Context
Like any other indicator even sentiment indicator lacks context. It primarily talks about what is happening in the market, irrespective of why it is happening. Infact one bitter truth about market is 98% traders / investors doesn’t have context with correct indication. All are taking their bets on certain probability of a trend to evolve.
Investors should use sentiment analysis as a supplementary tool and integrate it with other forms of analysis, such as fundamental and technical analysis. A well-rounded approach to decision-making, considering the limitations of each method, is essential for successful investing.
