What is Market Sentiment
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. In broadest terms, rising prices would indicate bullish market sentiment, while falling prices would indicate bearish market sentiment.
BREAKING DOWN Market Sentiment
Market sentiment, also called "investor sentiment," is not always based on fundamentals. Day traders and technical analysts rely on market sentiment, as it influences the technical indicators they utilize to measure and profit from short-term price movements often caused investor 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 often 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.
Some investors and traders profit by finding stocks that are overvalued or undervalued based on market sentiment. They use various indicators to measure market sentiment and to determine the best stocks to trade. These include the CBOE Volatility Index (VIX), 52 week High/Low Sentiment Ratio, Bullish Percentage, 50-day moving average and 200-day moving average.
Indicators of Market Sentiment
The 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, traders have a bearish market sentiment. When stock prices are trading at their highs, 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, market sentiment is extremely bullish and the market is likely overbought. Likewise, when the number is 20% or below, market sentiment is bearish and indicative of a market that is oversold. Traders sell when the market is overbought and buy when the market is oversold.