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Sentiment Measures at Trader’s Narrative




Sentiment Measures


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There are a lot of ways to gauge market sentiment. Here is a partial list of the more popular ones:

Most investment banks also have their own homemade one. As you’ve probably seen, Citi’s appears each week in Barron’s. I’m not sure what the eggheads over there are thinking when their sentiment index spends months and months in ‘panic’ territory. Mere mortals would head back to the drawing board.

And here’s an interesting one from the German investment bank, Dresdner Kleinwort Wasserstein:

DrKWsentiment.png
Source: DrKW via John F. Mauldin.

If you want to keep your sanity while checking on multiple sources of sentiment, here’s what you should keep in mind:

  • how was it calculated?
  • what are the inputs?
  • what exactly does it purport to measure?
  • how has it performed in the past?
  • has it identified tops or bottoms better?
  • in which time frame is it most successful: short-term or long-term?

By answering those questions, you will have a deeper understanding of each sentiment reading and will be able to separate them in your mind. You may even find they provide more insight as you layer different measures on top of one another.

The most common stumbling block when talking about market sentiment, is that people have different time horizons in mind. One may be assuming days or weeks and the other, months or longer. And so, eventhough they may both be right, they find themselves disagreeing.

To illustrate what I mean, look at the DrKW chart above.

While it was screaming “Irrational Exuberance” in late 2003 and early 2004, it wasn’t until August 2004 that the market corrected significantly. But if you had a shorter time horizon (weeks instead of months), you could have used other technical or sentiment tools to go long within that larger correction.

SP500sentiment.png

So next time you find yourself in a heated debate about sentiment: stop. Ask the other person what their time horizon is. You may just find that the disagreement evaporates.

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