What Does Sentiment Tell You?

• Posted by Greg Harmon
• on June 10th, 2014

Market Sentiment means a lot of things to a lot of different people. There are surveys done by II, AAII and others that attempt to measure market sentiment by asking respondents questions. That can be useful to track over time but also has issues. What if people say something different than they do? What if the respondents have different timeframes? The best you can hope for is that over a good size sample and over time, trends will play out (if the underlying macro trend of respondents does not change). And then pundits, traders and investors will find a way to interpret the results and manipulate the data. Things like ‘This is a slightly higher high and the angle is declining so perhaps a top has formed’. Of course it could be some extraneous macro factor, like weather or a Presidential election, that is causing the change. No one really knows. I am sure that the survey people do their best to eliminate this but can they really?

So what are you to do to understand market sentiment? On the television and other media the interpretation is nearly entirely negative so you need to create a scale of the degree of negativity. I do this a little bit. It has bounds of ‘sighting of Nouriel Roubini, Mark Faber and Peter Schiff” on one end and “any 3 pundits in one hour going positive” on the other end. But it is just a guide for me. You can trade off of sentiment but you cannot really trade off of sentiment data or its interpretation.

So why are traders, bloggers, pundits and investors so emphatic about what they see in the sentiment data? And they are emphatic, outside of the VIX being under 11 it is all that I see talked about all day long. The best I can tell is that they have an entrenched bias. And this is where my non-scientific study of sentiment comes in. One thing everyone can agree on is that bullish sentiment measures are high. It is the interpretation of that data that draws many opinions. But shouldn’t sentiment be high as markets are making all time highs? The best take away from this piece of data on high bullish sentiment is that it aligns with bullish price action.

The second observation I make is how emphatic the financial community is about their view. I measure this roughly on a scale of ‘people expressing an opinion’, to ‘people trying to convince’, to ‘people telling you why other people’s views are wrong’. We seem to be getting close to this extreme now. I can offer my opinion on how to interpret that (entrenched views on both ends) but it is just a guess. When someone goes from telling me what they know to telling me why someone else is wrong i tune out. What I have observed is when the community gets emphatic in their view price history is a better guide. You may attribute this to my bias as a technical trader. But logically if there are parties espousing that the top is in and everyone else is wrong, AND there are parties with the view that markets will keep going up and how can the bearish side continue to be so dumb, both cannot be right. And when they both start telling the other why they are wrong they all become noise. So who is more right? I do not know. It may make me tighten stops on trades but I let price tell me where the market may head.

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