Day traders rely heavily on technical indicators but also pay attention to market fundamentals. While indicators are based on past performance and fundamentals help us predict in the longer term, tapping into market sentiment helps in the medium term. Learn how to measure market sentiment and you can anticipate what the market will be doing and how your indicators will look in the coming days or weeks. A simple example is that if you find that a stock is being searched for on Google it will probably go up in price the following week. Reading market sentiment is seeing into the collective mind of the market.
What Is Market Sentiment?
Market sentiment is the term used to describe what traders of futures contracts, stock investors, and options traders are thinking about what they are trading. You can think of it as crowd psychology, a collective gut feeling. A commonly used indicator of sentiment in the stock market is the VIX. This volatility index looks at near term calls and puts in stock options and provides a reliable measure of how concerned (fearful) option traders are at the current time. Market sentiment is not a measure of what has happened or the fundamentals that will eventually drive prices but rather a glimpse at what concerns futures, options, currency, and stock traders at the current time.
What Is Sentiment Analysis in the Stock Market?
You may worry about the future course of the stock market or you may feel that there is no reason to worry about where stocks will go next. The problem for any investor or trader is that what you think and what the rest of the market thinks could be totally different. Smart traders and investors use tools to analyze market sentiment. You cannot see into the minds of others but you can read their actions. The VIX is one example where the ratio of calls to puts is indicative of the degree of worry in the market. Likewise, when there is a flight to safe havens like the US dollar or to “risk on” assets, or a change in CNN’s Fear and Greed Index any of these provides useful insight into evolving market sentiment and how it can drive the market in the days and weeks to come.
How to Find Market Sentiment
Traders find market sentiment by using market sentiment indicators. These indicators do not need to be derived from the market. While the VIX taps into what options traders are thinking by measuring the ratio of calls to puts, simply looking to see what is being searched for on Google is an indicator of what folks are thinking about even before they place a trade. When there is a rush to US Treasuries even when there has not been a big surge in interest rates it tells us that the market is worried about where stocks are going or afraid that commodity futures may be ready to collapse.
What Is a Market Sentiment Indicator?
A market sentiment indicator is a way to read the future of prices in any market. Traders do not simply rely on a Google search or a glance at the VIX to guide their trading. Rather they keep in touch with fundamentals of the market they are trading, assess technical indicators like moving averages, and then integrate what they have learned from market sentiment indicators. When a bull market is getting exhausted, market sentiment indicators help traders determine when it is safe to seek more profit or cash out and count profits while waiting for a correction.
How to Determine Market Sentiment
When considering how to determine market sentiment it is useful to think about how you use technical indicators. While one technical indicator may be too little, add several to the mix and two things happen. First, with each added indicator the incremental amount of insight gained tapers off and second if you are too busy reading indicators you will not have time to trade! The same applies to determining market sentiment. Successful traders typically use market sentiment indicators as secondary sources of insight after technical indicators and fundamental analysis.
How to Understand Market Sentiment
A useful way to understand market sentiment is to think of its indicators like you might think of information from a scout sent out to find a trail for your wagon train or assess the strength of an opposing army. When you try to read market sentiment, be aware of how far out the indicator may be useful. For example, the VIX looks at calls and puts up to a month ahead. The “Google indicator” is said to be useful for a week. However, the VIX is self-correcting because so many people base their trading on it. The trick is not just how to measure market sentiment but how to apply what you have learned.
How to Read Market Sentiment
Successful day traders use discipline to enter, manage, and exit their trades. There is a risk when one relies too heavily on market sentiment indicators. They are like stock or commodity tips. They need to be assessed in a frame of reference bounded by a sound sense of the fundamentals and disciplined application of one’s technical indicators. Besides looking ahead for clues about the market it is essential to work with a reliable real time data feed.