Sentiment analysis is a commonly used technical tool in trading. Market sentiment or trader sentiment works as indicators and helps traders determine their future moves. These analyses also help traders determine trends in the market.
What does stock sentiment mean?
Sentiment analysis in stock analyzes the position of other traders in the market, how other traders trade equities. Usually, stock sentiment analysis evaluates net short or net long trading positions within a particular stock.
Sentiment Analysis in the Stock Market
Sentiment analysis is basically a psychological analysis of the market that gives a view of how the price movement was in the past and gives a gist of how it can be in the future. In simple words, it helps traders understand the market’s mood and other investors to plan their own move. However, these sentiments are very uncertain and can be easily influenced by many factors such as news relating to the economy, politics or the industry, seasonal factors, price history, or even the investors’ expectations. These factors directly affect the trading volume and stock market volatility.
How Sentiment Help Traders to Anticipate Changes in Stock Prices?
Only stock sentiment solely is not enough to analyze the market. It needs to be paired with well suited technical analysis to give a clear picture of the future market situation.
As said before, market sentiment or trader sentiment is extremely uncertain and can be influenced very easily. Any news or information or social media post can affect the stock price in the market. This factor makes the stock prices highly volatile. Any negative news or information can make a stock lose its value in the market, while positive news can attract more and more investors, bringing the stock price to a new high. It is mainly because of the psychological factor that this news or information affects the faith of its investors in the stock.
For example, in his recent interview in 2021, the top footballer Cristiano Ronaldo removed the bottles of the carbonated beverage Coca-Cola from his table and replaced them with water bottles. His simple gesture cost the beverage giant $4 billion immediately. The stock price of the company fell by approximately $0.88 right away after the interview.
Although this has been seen most of the time when the technical tools show extreme readings, it is a sign of trend reversal. So, for example, when technical factors, like market sentiment, show that most traders are planning to exit the market or sell their stocks, this may be a sign of an approaching bullish trend.
How to Use Sentiment Indicators?
Sentiment indicators help ascertain the traders’ sentiment in the market and hence the sentiment of the market as a whole. For example, if the traders or investors sense that there will be a fall in the stock price in the market, they tend to start selling the stock more aggressively; this shows that the market sentiment is bearish. On the other hand, if the traders predict that there will be an uptrend in the stock price, they start purchasing the shares, and hence the market sentiment becomes bullish.
Following are some commonly used indicators that help in sentiment analysis of stock:
- Volatility Index
- Client Sentiment
- Put/Call Ratio
The CBOE Volatility Index or VIX is a market indicator that indicates the expected volatility or fluctuations in the stock price. It is based on the S&P 500 index and is forwarding-looking anticipation for a period of 30 days.
There is a negative correlation between the trader’s sentiment and the Volatility Index (VIX). When the traders expect the prices to show a downward trend, the Volatility index increases. On the contrary, when the traders expect the prices to uptrend, the VIX shows a downfall.
Many traders may also call the VIX a ‘fear gauge.’ This is mainly because of the reason that put options have more value as compared to call options because it works as a hedging tool for traders. And whenever there is an increase in the put options volume, the VIX also increases.
Client sentiment helps traders determine the number of long and short trades present in the stock market at a particular time. It helps them plan their future move according to the position of others traders present in that particular stock market. With the help of this indicator, they can estimate the approximate right time to buy or sell their stocks.
The Put/Call ratio can be clearly understood with the concept of options. An option or stock option is a method in which traders get into an agreement to buy or sell a specific stock at a pre-fixed price, also known as the strike price, by a pre-fixed date, also known as the expiration date. Two phases can further understand stock options. The first is a call option when the traders buy at price and date pre-determined. This opportunity is mostly used by traders when the stock is in a bullish trend. Second is the put option when the trader sells stock at a pre-determined date and time. On the contrary, this strategy is used when the stocks are in a bearish trend. In both cases, the put/call option helps traders hedge against the market risks.
The put/call ratio helps determine the market sentiment by calculating the ratio of the volumes of put options to call options in a single trading session. For example, a particular stock experienced call options by 8000 traders and put options by just 500 traders in a trading session. So, the ratio will signify that the market sentiment is bullish as the investors are expecting an increase in the stock price.
Frequently Asked Questions
What is the meaning of bearish and bullish stock markets?
A bearish stock market refers to a market that is approaching a downward trend. On the other hand, a bullish market is when the market is approaching an uptrend.
How can negative sentiments affect the stocks?
The negative sentiments refer to the situation that the traders in the market have negative thoughts towards the stock price. This means that they are expecting the price of the security to fall. This negative sentiment encourages traders to take the selling position. As a result, the stock takes a downward trend and could enter the position of over sales. This extreme position can further trigger a trend reversal.