What Is the Investors Intelligence Sentiment Index?

The Investors Intelligence Index is a common and widely accepted means of ascertaining the balance of power between the bulls and bears. In actuality, the index may refer to one of several possible sentiment indicators, including an advisor sentiment review and an insider activity review. These individual indexes are grouped according to representative sectors of market participants. Keep reading to learn more about this index and how it works.

Advisor Sentiment

The Investors Intelligence Sentiment Index may not necessarily be what it sounds like. Chartcraft actually refers to an advisor's sentiment, which is a culmination of the forecasts of the newsletter writers. The index is based on contrarian propositions—investment strategies that suggest equity traders should act opposite to the balance of expert opinion and market trends.

Newsletter writers issue independent advice from their publications and commentary. It studies more than 100 newsletters for deriving the Investors Intelligence Sentiment Index. The sentiment indicator assumes that a consensus trend is always about to reverse. This provides traders with the opportunity to capitalize on an imminent reversal in price movement. The signs of a reversal are strongest when the balance of opinion is strongly skewed in one direction.

The Sentiment Index Ranking

To make the index useful for traders, the company delineates a ranking system across all of its various indicators, ascribing a numerical ranking to each and every indicator, including the sentiment index.

Extreme bullishness is represented by any ranking that approaches -10. This indicates a potential downward change in the direction of the market. Extreme bearishness would be any number close to +10, which signals that the market is about to change in a positive direction. This means the bulls are taking control.

The negative rankings range from -1, which is assigned when the bulls are 51% or higher, up to -10, which is the maximum ranking, assigned when the bulls are over 60%. This is specific to the sentiment index and isn't a hard-and-fast rule for every index.

If the bulls fall below 45%, a +1 ranking is ascribed and if bulls fall to 36% or lower, the maximum reading of +10 is given. In the opposite direction, a -10 ranking is ascribed if the bears fall below 20%, and this ranking remains active for three months. The sentiment weighting can only ever reach a maximum -20 ranking.

Index Swings 

Investors Intelligence also indicates readings for rarer events. If the bears go above 55%, another +10 is added to the ranking for six months. We saw this back in December 1994. The bulls were up to 59%+ for two weeks in a row, emitting the highest level of bullishness registered by the index in 12.5 years.

Academic Research

Although the famous Investors Intelligence index was created in the 1950s and refined in the 1960s, it was not until the turn of the 20th century that the index was put to a rigorous test.

In the years leading up to the year 2000, writers from the University of Santa Clara conducted a study, written by Ken Fisher, chief executive officer (CEO) of Fisher Investments, and Meir Statman, the Glenn Klimek professor of finance at Santa Clara University. Their study demonstrated only a weak correlation between the Investors Intelligence Sentiment Index and major market turning points.

"We found the relationship between the sentiment of newsletter writers as measured by the Investors Intelligence survey and future S&P 500 returns to be negative but not statistically significant."

This criticism is why Investors Intelligence clarified the purpose of its indicator while providing a good illustration of exactly what investor sentiment is and what it isn't. Like any other indicator, the sentiment index usually tells you nothing. In fact, investor sentiment is ensconced in a normal range most of the time, where its neutral reading offers no useful trading indicator whatsoever. Investors Intelligence considers this normal range of being 45% bulls, 35% bears, and 20% correction.

The Bottom Line

The investor sentiment is most often neutral, but it can also be slightly too bullish or bearish. By contrast, the most significant signals are given by stronger bullish or bearish rankings and by the less common occurrences of significant event readings. Investors Intelligence sentiment index has exhibited a high correlation with major events and the actual performance of the markets.