• What is Sentiment Telling Us?

    by  • March 23, 2014 7:06 pm • Trading 101 with Peter Bryans

    Everyone has their own way of looking at sentiment. Some common methods for measuring investor’s/trader’s views on the market involves quantifying data (i.e. short interest, put/call ratios, fund flows), reading/listening to anecdotal evidence (i.e. what are “pundits” and media outlets saying?), or just looking at sentiment polls. Here’s an update on the third one that I have listed, followed by some of my thoughts regarding this current market environment.

    American Association of Individual Investors (AAII) Poll

    We received our usual weekly update this past week (I am referring to the week of Monday 3/17 – Friday 3/21) and the bullish sentiment declined nearly 5 percentage points. Here is a look at the survey results.

    (courtesy of AAII)

    Courtesy of our Quantitative Analyst, Chris Prybal, we have the S&P 500 plotted along with the poll results.

    National Association of Active Investment Managers (NAAIM)

    Then there’s the poll results of the “pros”–sometimes referred to as the “smart money”. Sentiment barely changed from the prior week. Similar to the AAII poll, I have the quantitative data and then a nice chart to go along with the numbers. The S&P 500 is plotted alongside this data.

    (courtesy of NAAIM)

    Market Sentiment Cycle

    Before my final thoughts, here’s a rather humorous illustration of investor psychology. You see these various levels at different stages in bear and bull markets. Since the infamous bottom of 666 on the S&P 500 in March, 2009,  we have been in what many consider a cyclical bull market (the secular debate is an entirely different discussion). In fact, we just celebrated the five-year anniversary of what was the beginning of a new bull market.

    (image found here)

    You can boil down the stages of the “sentiment cycle” into 4 main phases. Starting at the bottom (the end of a bear market–right before a new bull market begins) we have:

    1.) despair

    2. ) disbelief

    3.) acceptance

    4.) euphoria

    Then, at the other end of the spectrum (when a new bear market begins), we have the following phases:

    1.) euphoria

    2.) disbelief

    3.) acceptance

    4.) despair

    Conclusion

    Sentiment polls can be tricky, and should certainly never be used alone. Always remember that we should “watch what people do–not what they say“. In my opinion, we are nowhere near that euphoric stage. It certainly seems that we’re in the acceptance phase–how far along is an entirely different question.

    From an anecdotal standpoint, I’m just not seeing that euphoria out there. The word “overvalued” is being beat to death. We should always do our best to combine quantitative data, anecdotal evidence, market technicals, and market fundamentals to try and paint a “clearer” picture. This game is never easy–just don’t spend all your time trying to call the top.

    From a swing trading perspective, do your best to find the absolute best setups. The environment has been tough compared to last year.

    Good luck out there.

    About

    Peter Bryans joined the Schaeffer's Investment Research trading team as a Trader in April, 2012. A graduate of the Fisher College of Business at The Ohio State University -- where he concentrated in Finance -- Peter previously held internships with an insurance broker and a wealth-management firm. In his current role, Peter trades a variety of our real-time option services and also hosts our "Options Apprentice" weekly webinar presentations.

    http://www.schaeffersresearch.com