lecture 11: sentiment Flashcards
Sentiment
the net amount of any group of market players’ optimism or pessimism reflected in any asset or market price at a particular time
when is a price reversal is usually due?
When emotion becomes excessive and prices thereby deviate substantially from the norm
The market is made up of which 3 types of players
The informed
the uninformed
liquidity players
The majority of market players
The informed
The retail investors – the public at large, those who tend to chase the market
They are the ones who tend to buy at peaks and sell at market bottoms
Even professionals can be classified as uniformed. It is the timing of their actions that qualifies them as uniformed players.
The informed market players
tend to act in a way that is contrary to the majority
CROWD BEHAVIOR
People tend to conform to their group, making taking an opposite view difficult, fear of rejection, ridicule, hostility etc.
People feel secure in accepting the opinions of others or “experts”.
As people “follow the herd” they get caught up in extreme buying or selling, pushing prices to extreme levels.
These emotional excesses can result in crashes or bubbles and going against the crowd before the peak or bottom could be dangerous
CONTRARY OPINION
a school of thought in investing which is the opposite of crowd behavior.
It involves doing the opposite of what the majority is currently doing. That is, to sell when the majority is buying and to buy when the majority is selling.
The task of the contrarian player is to find a way in which to quantify which direction the majority of market players is headed and to question whether they are reaching an extreme and whether there is enough energy to keep the market moving in that direction
Sentiment Indicators
data sets that give the technical analyst some feeling for how much prices are at emotionally excessive levels
Emotional excess is often sharpest at market bottoms when panic has occurred.
On the other hand optimism can last for a long while.
–> Therefore, most sentiment indicators are more useful in determining market bottoms when fear has reached an excess
How is sentiment of uninformed players measured?
SENTIMENT INDICATORS BASED ON OPTIONS AND VOLATILITY
POLLS
OTHER
SENTIMENT INDICATORS BASED ON OPTIONS AND VOLATILITY
PUT/CALL RATIO
Total volume of puts traded in a day / Total volume of calls traded in a day
If the put/call ratio is high
what if its low
this would represent more puts being traded with respect to calls, which in turn, means that the market participants are more bearish than bullish
A low put/call ratio would imply the opposite
SENTIMENT INDICATORS BASED ON OPTIONS AND VOLATILITY
VOLATILITY
We look at the VIX which is the implied volatility of the S&P 500 options
how can we use the VIX (or implied volatility)?
implied volatility measures are forward looking and not backward looking, we can use them to gauge where the market will be going in the future
when does High Volatility tend to occur
what about low
at periods of stress, emotion, uncertainty, fear and nervousness most often peaking at a panic bottom
Low Volatility tends to occur during market rises and market peaks when emotions are calm, content and relaxed
Generally, what does it mean when the VIX trades high?
what about low?
there is some sort of a sell off that occurs,
when it trades at a low level, the market tends to increase
when does the VIX tend to rise exponentially?
when the market comes under selling pressure
POLLS
simply to ask the players if they are bearish or bullish.
Sampling problems do exist though.
Poll results if measured over a constant time can give some idea of the public mood
why are Poll results contrary opinions?
because they express optimism at market tops and pessimism at market bottoms
Polls
advisory opinions
Investor Intelligence reads approximately 120 investment advisory newsletter every week and determines the percentage of them that are bullish, bearish or expecting a correction
Polls
AMERICAN ASSOCIATION of INDIVIDUAL INVESTORS (AAII)
Compiles a weekly poll from its 150 000 members on what they believe the stock market will do over the next 6 months
Polls
CONSENSUS BULLISH SENTIMENT INDEX
Compiled from an extensive mix of both brokerage house analysts and independent advisory services, to create the Consensus Bullish Sentiment Index
covers a broad spectrum of approaches to the market, including the fundamental, technical, and cyclical.
They consider only opinions that have been committed to publication and therefore have an influence on the trading public
Polls
MARKET VANE
Polls 100 leading commodity trading advisors for their opinion of the futures markets
This data is then used to construct the Bullish Consensus statistics, which is published in Barron’s weekly
Polls
THE SENTIX INDEX
comprehensive poll of German investors regarding their views on the German as well as the US stock and bond markets
They poll 3100 participants (of which 690 are institutional investors) on what their opinion is for different markets over the next month and next six months
Polls
CONSUMER CONFIDENCE INDEX
based on a representative sample of 5000 US households.
The survey is based on expectations of the US economy.
Like most other opinion polls, the survey has been a contrary indicator to the stock market
OTHER MEASURES OF CONTRARY OPINION:
MUTUAL FUND CASH AS A PERCENTAGE OF ASSETS
Mutual fund cash holdings are contrary indicators for the stock market
There are many reasons for mutual funds to hold cash, but the bottom line is that high levels of cash usually occur at stock market bottoms
OTHER MEASURES OF CONTRARY OPINION
MARGIN BALANCES
Margin debt should reflect what the uniformed investor is doing (as margin debt is usually comprised of individual investors taking on debt to speculate on the market)
measure has been proven not to be as useful as previously thought due to the ability to take positions with derivatives
OTHER MEASURES OF CONTRARY OPINION
NASDAQ to NYSE VOLUME
A ratio of volume traded on the NASDAQ relative to the NYSE is a measure of speculation
when does the volume traded on the NASDAQ usually increase relative to the NYSE?
Generally as enthusiasm for speculative stocks (which usually trade on the NASDAQ) increases
when do we see the peak of the NASDAQ to NYSE VOLUME ratio
The peak in the market
OTHER MEASURES OF CONTRARY OPINION
UNINFORMED SHORT SELLING
Generally short selling has been used a contrary indicator
we use the short interest ratio
the short interest ratio
calculated on a monthly basis by taking the total amount of stocks sold short and dividing by the average volume for the month
When percentage of short sales to total trades increases, what does this mean?
this indicates a bearish extreme and the market is likely to rise
UNQUANTIFIABLE CONTRARY INDICATORS
MAGAZINE COVERS THEORY
The media covers the news with a strong bias. If the stock market is high and ready to decline, the media would be unlikely to report this point of view. Instead it would emphasize the current fact that the market has risen and is strong
How is sentiment of Informed players measured?
INSIDERS
the ultimate informed players
No one knows their business, industry or company like an insider.
SEC regulations require that insiders must report their transactions within 2 days now, and these stats are published by the SEC
How is sentiment of Informed players measured?
SELL/BUY Ratio
compiled by Vickers Stock Research Corporation, a subsidiary of Argus Research Group
takes into account the total number of insider buy and sell transactions for each company, the percentage change in insider holdings, the unanimity of the transactions within each company, reversals in transaction patterns and very large transactions
SELL/BUY Ratio when it is bearish or bullish
Total # insider sales / Total # insider buys
if > than 2.25 = bearish
if < than 2.00 = bullish
How is sentiment of Informed players measured?
LARGE BLOCKS
Tend to be transacted on behalf of professionals, or the informed players.
Large institutional clients are the ones who transact these blocks, and most often than not, whether they are buying or selling has a say in what will likely happen in the future to the stock.
The ‘smart’ money tends to be behind these trades
