First of all, when people talk about investor sentiment, or market sentiment, they are referring to the aggregate attitude in the investment community. Essentially, investor sentiment is an approximate measurement of the stock market's attitude at a given time—it could be overly bullish, bearish or somewhere in the middle. This type of analysis would usually be employed by a short-term trader or technical analyst trying to reap profits from short-term movements in stock prices. For example, if a short-term trader saw stock prices rising across the board, it would probably be a good indication that market sentiment is currently bullish. In other words, there are many more people who are willing to buy stocks and bid up prices than there are those willing to sell.
Specific quantitative methods have been developed in order to attempt to measure (as best as possible) investor sentiment. Companies such as Chartcraft publish sentiment indexes that provide investors with a running measurement of market conditions. Chartcraft's Investors Intelligence sentiment index quantifies and compiles investment advisor reports and insider activity to gain a bird's-eye view of the market's overall outlook. Companies like Chartcraft publish their sentiment indexes on an ongoing basis, so investors can track the changes in market sentiment over time and use the information to attempt to predict turning points in bull and bear markets.
By noting changes in market sentiment, investors attempt to determine whether the market's mood is too bullish, too bearish or relatively normal. If investors can obtain an accurate measurement of the market's sentiment, they can use it for their benefit. For example, if Chartcraft's Investors Intelligence index (a contrarian methodology) shows that the market is currently extremely bullish, an investor employing the index would take that information to mean that the market will soon take a correction as it returns to normal sentiment conditions. Thus, an investor who wanted to go long in blue-chip stocks would not buy stocks at this time but would wait until the market sentiment index changed to bearish conditions, hopefully making stocks underpriced and set for a strong upward run. (See also: What Is the Investors Intelligence Sentiment Index?)