Sentiment can be thought of as the overall mood of the financial market. This gauge of the median psychological state reflects the price movements in the market.
Essentially, rising prices gauge bullish sentiment, while falling prices signal a bearish sentiment towards the security.
On a short term basis, price movements are not always or entirely based on fundamentals. Several factors come into play - from risk management to exogenous factors - and these include the buy and sell activity driven by psychology and sentiment.
As an example, sentiment in the market turned bearish towards the end of 2021 when inflation was nearing all-time highs, supply couldn’t keep up with the rising demand and company valuations began to appear stretched .
After almost 2 years of double-digit price appreciation, thanks to the injection of wealth into the economy and quantitative easing, investors finally began to suspect the “party” was coming to an end - and that a correction was on the way. This eventually led to the start of the H1 2022 bear market.
Here are a few examples of popular indicators which can be used to measure market sentiment:
- The VIX. Also known as the fear index, the VIX gauges the price of 1M and 2M options on S&P 500. A rising VIX implies that there is more fear in the market and investors seek protection from downside .
- The AAII Investor Survey The AAII indicator is one of the longest-standing surveys of market sentiment. Starting in 1987, the AAII Investor Sentiment Survey queries investors’ views on the market in the next 6 months and provides a gauge to determine moments of extreme exuberance or gloom.
- The High-Low Index This index tracks the number of stocks making 52-week highs (prices hitting the highest level observed over the last year) versus the number of stocks hitting 52-week lows. When the index value is below 30, that means stocks are trading near lows and investors have a bearish market outlook. On the other hand, a value above 70 means stocks are trading towards their highs and investors have a bullish market outlook.
- Bullish Percent Index The BPI measures the number of stocks with a bullish pattern based on point and figure charts. Similar to candlestick charts, P&F charts look at the degree of asset movement however without considering a specific time period. Neutral markets usually have a BPI of 50%, overbought markets have a reading of 80% or higher and oversold markets have a BPI of 20% or below.
- Moving Averages The most commonly used moving average is the 50 to 200 day moving average. When the 50-day moving average crosses above the 200-day moving average (golden cross), this indicates momentum has shifted to the upside, suggesting bullish sentiment. On the other hand, the 50-day moving average falling below the 200-day moving average (death cross), indicates momentum shifted to the downside and hence bearish sentiment.