Market sentiment is the average sentiment toward a market or stock. The sentiment is considered bullish if the stock or market is trending up and seems like it will continue. If the stock or market is trending down, the sentiment is considered bearish.
Market sentiment is a widely used term among short-term traders.
Understanding Market Sentiment
Market sentiment, sometimes referred to as investor sentiment, does not correlate to fundamental changes in the market. Technical analysts and day traders rely on measurements of market sentiment as it influences the indicators used to measure and profit from short-term price moves. The crowd psychology of active investors causes these indicators.
Contrarian investors also use market sentiment as they trade in the opposite direction of the prevailing consensus. For example, if everyone buys a stock, a contrarian would sell it to profit from the move upwards.
Emotions drive the stock market, so market sentiment is not related to the fundamental value of a stock. Prices can change for many reasons beyond what a fundamental analysis would deduce.
However, market sentiment demonstrates broad concerns, expectations, and emotions about the market, while fundamental value concerns real business performance.
How to measure market sentiment
Below are a few of the technical indicators that are used to measure market sentiment.
- VIX
The Chicago Board Options Exchange Volatility Index (CBOE Volatility Index), or VIX, gauge anticipated volatility for the next thirty days. The CBOE volatility index is computed based on the implied volatility incorporated into market option pricing. The higher the VIX, the higher the volatility throughout the upcoming month is predicted.
However, the specifics of how it operates that even a novice investor can understand are explained here.
The price of an option is made up of implied volatility and intrinsic value. Intrinsic value refers to the difference between the option’s strike price and the cost of the underlying security. You would receive the intrinsic value if you immediately executed the option.
Also, traders expect more volatility over the option’s term when the difference between the option’s price is higher than the intrinsic value. The VIX is a good indicator of market sentiment regarding volatility. However, it doesn’t tell you which direction that volatility will go in because it includes both calls (bearish) and puts (bullish) in its calculation.
Therefore, the option price is usually worth more than the intrinsic value because there is a chance that the underlying security price will change before the term is up, which means the intrinsic value could increase.
- High-low index
The high-low index refers to the number of stocks in the index that are setting new 52-week highs relative to the number that are setting new 52-week lows. When it is 30, an indication is deemed bearish and bullish when it is seventy.
- Moving averages
Those that track trends often utilize moving averages. The stock’s average price or index over a predetermined period is known as the moving average. The 50-day and 200-day are the most often utilized numbers.
When the 50-day is above the 200-day, an indication is bullish, and vice versa. Traders keep an eye out for crossovers. The bullish mood shifts to bullish when the 50 crosses above the 200, and vice versa.
- Bullish percent index
The stocks in the index’s chart patterns create the bullish percent index. A bullish pattern on 80% of the index indicates a bullish mood in the market. If only 20% of people are bullish, it gives a pessimistic feeling.
- COT
Commitment of Traders report, or COT, is a popular sentiment indicator for commodities traders. It lists the futures assets held by different commodities dealers. This report is widely used as a contrarian indication.
Conclusion
Market sentiment is an example of crowd psychology. As market participants respond to the latest news, rumors, or projections, optimism or pessimism grows and spreads.
Additionally, bullish market sentiment is marked by rising prices, while falling prices indicate bearish market sentiment.
However, the long-term investor would be wise to stay above the fray. The bulls are just resting when the bears are in charge.
