Stock Market Sentiment Indicators Technical Analysis

There is an art as well as a a science to predicting where certain markets are headed due to the actions and behaviors of other investors. This is known as “stock market sentiment.” Compared to the more traditional approach to buying when stocks are undervalued, sentiment is a measure of emotion in the market place

What Is Stock Market Sentiment?

Stock market sentiment is the overall stance taken by investors towards a given market or security. By “sentiment”, experts are referring to a collective psychology from a group of people that makes up the market. It isn’t necessarily a conventional means of determining value in stocks, but rather a means to gauge a reaction among traders and investors to forecast where the market will be headed.

There are many factors that change price movements in a given market. This includes economic or financial reports, seasonal changes, technical factors, and even political events.

Studies have shown that news and social media can also play a role in the stock market, as informational and emotional aspects of certain news and events have the uncanny ability to affect stock prices, volatility, trading volume, and company earnings.

How To Use Stock Market Sentiment Indicators

Market sentiment indicators can help investors trade as long as they understand what is being measured and the indicators are used in the intended ways. Sentiment indicators alone cannot help you determine when you should sell or buy a security – beyond certain rules of thumb.

When combined with other forms of decision-making, such as technical analysis or fundamental analysis, you can get a better understanding of what action to take.

Generally, sentiment indicators can interpret one of two possible outcomes, which are named “bullish” and “bearish” sentiments. When analysts and investors are predicting a price to go up, they will deem the market sentiment as bullish. When they predict a price to go down, they will call that sentiment bearish.

Market sentiment indicators are also capable of telling if a certain market can also reach an extreme high or low. If this happens in a market, the sentiment indicator can incline a trader to assume a contrary position.

For example, if 450 out of 500 trades are short positions, there may be fewer orders remaining to pressure the price lower. Short covering trades will therefore need to be made in order to close out the bearish positions. Therefore, there will be a very high probability of a bullish reversal. The short version of that example is that market sentiment indicators can interpret contrarian signals in a market.

There are a number of sentiment indicators that can be used to measure sentiment. Each are unique in their own right and tell a different story of what is going on in a certain market. It’s worth looking into using any tools or indicators that contribute towards making well-informed trade decisions. Here are some of the most common sentiment indicators used by experts and investors in stock.

Volatility Index: Most Popular Sentiment Indicator

Also known as VIX, the Volatility Index measures the expectations of where a market is going in the future. Another name for the Volatility Index is the fear index, as it tends to increase when investors become pessimistic in the market.

This is among the most common indicators used among equity traders. This indicator is calculated from call-and-put options prices that are found in the S&P 500 Index options. Put options prices will often carry a greater load than call options prices.

The Volatility Index was inspired by the fact that investors buy put options so they can protect their portfolio from unfavorable price changes.

When investors predict a scary decline in the market, they buy put options in order to hedge their portfolios. When there is a demand for put options, the prices increase and thus the Volatility Index spikes.

Therefore, there is a bearish marketing sentiment as the Volatility Index rises. A falling Volatility Index indicates prices won’t change unfavorably, which is what investors prefer.

Put/Call Ratio: What Does It Mean?

Put/Call Ratio refers to the comparison of the volume of put options to the volume of call options on the same security in the same trading session. With this indicator, you can determine how much bullishness or bearishness is in the security. This is a market sentiment indicator that people use to precisely gauge investor sentiment in a given stock.

Individuals can calculate the Put/Call Ratio for any security that has tradable option contracts. These include commodities, individual stocks, and stock indexes.

When a Put/Call Ratio is used to calculate a broad market index, such as the Dow Jones Industrial Average, it can give you the stock market sentiment. When a single stock is calculated, however, you can then see the stance that investors have taken with that given stock.

What Does The Skew Index Tell Investors?

The CBOE (Chicago Board Of Exchange) Skew Index is an option-based indicator that can only be used with the S&P 500 broad market index.

It can be used to gauge volatility and the possible risk of a “black swan” event. How this indicator works is that investors get to see the perceived “tail risk” of the distribution of S&P 500 returns in the next 30 days from today.

Tail risk means a change in price on the S&P 500 index where the price is put on a “tail” or far point of the normal distribution curve. What the Skew Index measures from there is the slope of the volatility in question.

As the slope of the volatility rises, the Skew index also rises. This would indicate that a major market-changing event is imminent. This is not always the case, however.

The Skew Index will generally range from 100 to 150. When the price reaches this range, investors will tend to hedge their portfolios and/or add to existing hedges. The Skew Index can also work in conjunction with the Volatility Index.

How Does The TRIN Work?

Also known as the Arms Index and the Short-Term Trading Index, this is an indicator used by traders to determine general market sentiment. With this index, the relationship between market supply and demand is measured. To get the TRIN Index, the advance/decline ratio is divided with the up/down volume ratio.

Traders use the TRIN Index to forecast market trends by comparing it to a stock market index. If the TRIN index is higher than 1.0, and the market index is on the decline, it reveals the market sentiment to be bearish.

If the TRIN index is much higher than 1.0, such as at 2.0 or 3.0 this can indicate a bullish market sentiment with the market being oversold.

NYSE High/Low Indicator: How Does It Work?

The NYSE (New York Stock Exchange) High/Low Indicator draws a comparison between the amount of stocks making new 52-week lows to stocks making new 52-week highs.

If more stocks hit 52-week lows than highs, the market sentiment is known to be bearish. When there are more 52-week highs than lows, the market sentiment is instead bullish. Traders are among the types of people in the stock industry that use this indicator for gauging marketing sentiment.

The High/Low Indicator is often used with a broad market index. Traders come to the conclusion of a strong trend when both the broad market index and High/Low Indicator are flowing in the same direction.

This is considered good, because if the market index is showing a new high, then the High/Low Indicator will also rise. The opposite is also true when the market index shows a new low.

Smart Money Index: What Is It?

An indicator that is known to be more practical than technical, the Smart Money Index is a measurement of “smart money” in comparison to “dumb money” in a market.

This indicator is centered around the concept of “dumb money” trades that happen within the first half hour of every market day. These trades tend to happen when traders are concerned due to reading or watching news or data the previous night.

“Smart money” trades are known to take place during the hour before the market closes for the day. Investors who are “smart” will take the opportunity to see how the market performs throughout the day before trading towards closing time. The idea is to bet against the morning price trend in favor of the evening price trend.

The Smart Money Index can be calculated with a broad market index and contains a rather simple formula. You take the Smart Money Index from yesterday, subtract the opening gain or loss, and then add the last-hour change to get the current-day Smart Money Index.

While critics of Smart Money Index see some worth in this indicator, they argue that other indicators work better to interpret market sentiment.

Stock Market Sentiment Indicators Technical Analysis

Technical analysis is a form of strategy that, while doesn’t draw any conclusions, simplifies trends so that traders can make good decisions in response to what data is shown.

Traders rely on technical analysis religiously in order to produce a consistent interpretation of data in the stock market. With this in mind, the success of that strategy depends on the trader or investor who uses it.

There are many indicators for traders and investors to use to help determine where markets are going. Suggestions for how to be successful in using indicators include understanding the nature of your market, knowing what your indicators of choice do, and have technical (or fundamental) analysis help you paint a better picture of your market. Knowing how to use a certain indicator can help you better understand trends in your market.

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The author has no position in any of the stocks mentioned. Financhill has a disclosure policy. This post may contain affiliate links or links from our sponsors.