Have you heard about market sentiment? Well, this term signifies the overall vision and consensus about the stock market as a whole. Other than that, the term can even be used in order to signify the consensus of any particular stock.
Investor Sentiment Index or Investor Poll or market sentiment survey defines the overall attitude and impression of the individual investors toward any specific stock or entire financial market. Since it defines the tone and overall movement of the market, it further helps you in identifying when the prices are rising or when the prices are falling.
Especially, if the market sentiment turns bullish, then it’s expected that the price movement of the securities/bonds/stocks traded in the market should be rising up. Similarly, a bearish market sentiment indicates that the price movements are in the downward or falling direction.
American association of individual investors sentiment survey chart
American association of individual investors AAII Investor Sentiment Survey by SwissView on TradingView.com
Why market sentiment is important?
In the previous sections, you have already learned about market sentiment. Now, here’s the next question — why it is so important? Well, market sentiment is nothing but the overall crowd psychology. Many investors use this parameter in order to find out when you can make profits from the market. In addition to it, the parameter also helps you to understand when it’s the right time to sell and buy. Both technical analysts and day traders rely on this parameter i.e. investor sentiment index.
They use this investor sentiment index in order to monitor and decide which short-term price movements can offer maximum profits. This parameter is also helpful for contrarian investors as well. These contrarian investors typically follow a reverse trade trend. For example, they usually prefer to go for the opposite direction of a prevailing market consensus, such as when everyone is buying one stock based on the market sentiment, a contrarian investor will rather attempt to sell that stock.
In an overall note, it can be mentioned that market sentiment is an important parameter to find out both overvalued and undervalued stocks based on crowd psychology. Investor sentiment can even help you to pinpoint which are the best and most lucrative stocks to trade.
Various investor sentiment index indicators
Market sentiment is all about crowd feelings, psychology, and emotion. It can be both bearish as well as bullish. There are different types of investor sentiment index indicators, for example, individual investor survey, retail investor survey, High-Low Index, VIX or CBOE Volatility Index, moving averages, and Bullish Percent Index or BPI.
CBOE volatility index or VIX
This parameter is alternatively named as the fear index. It is driven by options prices. For example, if the VIX value is rising, then it indicates that there are volatility and instability in the market. Hence, there will be increased needs for insurance. Thus, this parameter warns investors when they should be careful.
The high-low index
This index compares the stocks based on the two different parameters, such as 52-week highs and 52-week lows. If the overall index result becomes below 30, it indicates that the stock prices are rising down and there is a possibility of bearish market sentiment. On the contrary, if the index result has become above 70, it indicates that stock prices are rising up and there is a possibility of bullish market sentiment.
Bullish percent index
BPI is calculated based on the bullish patterns of the stocks. Typically, the neutral markets will have a bullish percent index or around 50%. When the BPI value is either 80% or above, it indicates that the market sentiment is extremely optimistic. If the BPI value is 20% or below, it implies that the market sentiment is negative.
Moving averages
There are two types of moving averages, such as 50-day simple moving average and 200-day simple moving average.
For a particular stock, if the 50-day simple moving average crosses above the 200-day simple moving average, the situation is then referred to as the golden cross i.e. there are the chances of bullish sentiment. Similarly, the 50-day simple moving average crosses below the 200-day simple moving average, the situation is then referred to as the death cross i.e. the chances of bearish sentiment.
The final takeaway
With this, you have revealed all the details of market sentiment, how it works, why it’s important, and more. Speaking of a real-life example, the market sentiment turned completely bearish in December 2018 due to many factors, such as trade war between China and the US, slowed down corporate earnings, slowing economy, and more. This bearish sentiment totally damaged investor faith and confidence and as a result, the stock market witnessed the worst December performance.
Thus, market sentiment can bring both positives and negatives in the financial market. As an individual investor, you must be careful about this parameter and use this indicator to make wise investment decisions.
