Market sentiment is the overall attitude of investors toward a particular security or financial market. Market sentiment is the feeling or tone of a market, or its crowd psychology, as revealed through the activity and price movement of the securities traded in that market. For example, rising prices would indicate a bullish market sentiment, while falling prices would indicate a bearish market sentiment.
Market sentiment is also called "investor sentiment" and is not always based on fundamentals. It is important to day traders and technical analysts that use technical indicators to measure and profit from the short-term price changes often caused by investors' attitudes toward a security. Market sentiment is also important to contrarian investors that like to trade in the opposite direction of the prevailing sentiment. For example, if everyone is buying, a contrarian would sell.
Market sentiment is generally described as bearish or bullish. When bears are in control, stock prices are going down. When bulls are in control, stock prices are going up. The market is driven by emotion so market sentiment is not always synonymous with fundamental value. That is, market sentiment is about feelings and emotion, whereas fundamental value is about business performance.
Traders make money by finding stocks that are overvalued or undervalued based on market sentiment. Investors and traders use various indicators to measure market sentiment to determine the best stocks to trade. Some of these indicators include the CBOE Volatility Index (VIX), 52 week High/Low Sentiment Ratio, Bullish Percentage, 50-day moving average and 200-day moving average.
VIX, also known as the fear index, is driven by option prices. Options are insurance contracts and an increase in the VIX means an increased need for insurance in the market. If traders feel the need for more risk, it is a sign of increased price movement. Traders use moving averages of the VIX to determine when it is high or low.
The high/low sentiment indicator compares the number of stocks making 52-week highs to the number of stocks making 52-week lows. When stock prices are trading at their lows across the board, it means traders have a bearish market sentiment. When stock prices are trading at their highs, it means traders have a bullish market sentiment.
The bullish percentage measures the number of stocks with bullish patterns based on point and figure charts. Normal markets have a bullish percentage of around 50%. When the measure is 80% or higher, it means market sentiment is extremely bullish and the market is likely overbought. Likewise, when the number is 20% or below, is it is a bearish market sentiment indicative or market that is oversold. Traders sell when the market is overbought and buy when the market is oversold.