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Sentiment During a Bear Market at Trader’s Narrative

Sentiment During a Bear Market

John, from Tale of the Tape, asks a very interesting question regarding the nature of sentiment during a bear market. He wonders whether high bearish sentiment is a bullish signal during both bear and bull markets.

Well, lets examine the bear market that began in early 2000 by looking at the S&P 500 index and the absolute readings of AAII bearish sentiment that accompanied it:

SP500 bearish sentiment 2000.png

Now, be mindful that the dates for the survey and the weekly candles don’t match exactly. What I’ve done is to round ahead to the next candle/week. So for example, if the survey date is May 12th and there are two candles with start dates May 8th and May 15th, I put the “sentiment” dot on May 15th’s candle. Capisce? The result is that in some instances it may appear that sentiment was ‘off’ or ‘late’ in signalling a rally… where it wasn’t really.

Some observations from this first phase of the bear market:

  • first heavy bearish sentiment was waay off for the S&P (much better for Nasdaq)
  • ditto for the lighter one that came right after it
  • sentiment didn’t get bearish again for a long time
  • but when it did, it was a great signal for a rally in March 2001
  • in early stages of a cyclical bear market, sentiment can be a great tell
  • but only after the market has seen a significant decline and/or correction

And the next phase of the bear from 2002 onward:

SP500 bearish sentiment 2002.png

Wow! The graph lights up like a Christmas tree:

    bearish sentiment went haywire approaching 1000 - right at previous support
  • naturally, a lot of people became bearish as the index revisited its lows
  • bearish sentiment accompanied the index’s plunge!
  • clusters of major bearish sentiment can actually be dangerous!
  • it is much better to get a lone ‘dot’ than a crowd of them (see first graph)
  • you need severe and sustained bearish sentiment for a significant bottom
  • bearish sentiment can ‘wash out’ - no real bearish reading after March 13, 2003

But remember that sentiment, especially only one measure of it such as AAII, should never be used as a tell in isolation. Sentiment as a contrarian measure is useful, but it must be combined with other tools to round out a picture.

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3 Responses to “Sentiment During a Bear Market”  

  1. 1 John

    Thanks for taking the time to answer my question.

  1. 1 Detecting Market Bottoms with Jim Cramer on InvestorGeeks
  2. 2 Sentiment Overview: Week Of June 13th, 2008

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