Market Sentiment
What Is Market Sentiment?
The general prevailing attitude of investors as to anticipated price development in a market is called Market Sentiment. It is the overall attitude of an investor towards the financial market. It basically defines the investor’s outlook towards particular securities.
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How Does Market Sentiment Work?
Market sentiments can be bearish or bullish. This happens because when the bears are in control, stock prices are going down thus creating bearish market sentiments. Alternatively, when the bulls are in control, stock prices rise thus creating bullish market sentiments. Taking advantage of these sentiments, investors profit by finding stocks that are undervalued or overvalued.
Indicators/ tools used to measure market sentiments:
- The VIX:
The VIX also referred to as the fear index, is driven by options prices. A rising VIX indicates that there is a need for insurance in the market. When the traders feel the need for protection, it means that there is an increase in volatility.
- The High Low Index:
This indicator includes comparing the no of stocks making 52-week highs to no of stocks making 52-week lows. An index below 30 indicates that stock prices are trading at lows and have a bearish sentiment. Alternatively, if an index is above 70 stock prices are trading at their highs and have a bullish market sentiment.
- Bullish Percent Index:
This index measures no. of stocks having bullish patterns based on the charts and points. A BPI of 50% states that the market sentiment is neutral, a BPI of 80% states that the market sentiment is highly optimistic and likewise a BPI of 20% states that the market sentiment is negative.
- Moving Averages:
Typically, investors use 50 days SMA and 200 days SMA for determining market sentiments. When 50 days SMA > 200 days SMA, it forms a ‘Golden Cross’, creating a bullish sentiment. Conversely if 50 days SMA < 200 days SMA, it forms a ‘Death Cross’, generating a bullish sentiment.
Trade using market sentiment:
- Perfect Sentiment Trade:
The best trades happen when the current sentiments are in line with a big picture fundamental. These trades are great because long-term investors use their fundamentals and short-term traders use their sentiments to get in and out of their trades. The simultaneous actions push the stock price thus creating an advantage situation. During this action, investors can make a lot of pips which they would have otherwise not. A positive fundamental creates a positive market sentiment and a negative fundamental creates a negative market sentiment. These trades last longer as the market participants are trading in the same manner.
- Counter Sentiment Trades:
In these trades, the market sentiments and fundamentals are extremely opposite of each other.
If fundamentals are ‘positive’ and sentiments are ‘negative’, we have 2 options:
- Allow negative sentiments to bring the price back where it makes fundamental sense to buy again.
- Trade the negative sentiments short against positive fundamentals.
If fundamentals are ‘negative’ and sentiments are ‘positive’, we have 2 options:
- Allow positive sentiments to bring the price back where it makes fundamental sense to short again.
- Trade positive sentiments long against negative fundamentals.
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Bottom Line:
Market sentiments in simple terms are the mood in the market. It can last from seconds to a few weeks depending on the nature of the sentiment. Emotions often drive the stock market, so the market sentiment is all about feelings and emotions. Technical indicators tend to be very useful to investors for measuring market sentiments.
Author: Urvi Surti
About the Author:
Urvi is a commerce graduate and has a keen interest in Finance. She has completed her Chartered Wealth Management (CWM) from the American Academy of Financial Management and is currently pursuing a career in Financial Risk Management (FRM).
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