Market sentiment is the sum of investor attitudes and beliefs about an individual stock or a particular financial market. It is the tone or overall feeling that is driving stocks up or down. Commonly used indicators or market sentiment include safe haven assets, the put to call ratio, VIX index, high/low index, risk on assets, CNN’s fear and greed index, and stock price breadth.
How to Measure Market Sentiment
The current state of greed or fear in the market can be approximated by looking at how market sentiment is driving various indicators. For example, by looking at the number of stocks that are hitting 52-week highs versus those that are hitting 52-week lows. An index of thirty or lower correlates strongly with a bearish market while an index above seventy goes with a bull market. Traders typically use this indicator within a given index such as the S&P 500 in an attempt to forecast subsequent market movement.
How to Trade Market Sentiment
The point of following market sentiment is to stay a step ahead of the market. A simple indicator of activity in a stock is the number of times it is searched for on Google. A high number of searches accurately predicts more trading of that stock in the following week. When safe haven assets are being purchased at a high rate it indicates fear of a market downturn and trouble in the economy. When an individual stock is in trouble or likely to go up, sentiment indicators for that stock alone with help traders anticipate price changes.
How Market Sentiment Affects Share Price
Think of market sentiment as the average of investor worries or investor excitement about a given stock or market. Smart traders and investors do a bit of research before jumping into a new equity. Thus there is commonly a lag between changes in market sentiment and changes in share price. Positive market sentiment drives share prices up and negative market sentiment drives share prices down. In general, the strength of market sentiment is related to the degree of share price changes.
How to Determine Market Sentiment
There are several reliable ways to track market sentiment. As a practical matter, how to determine market sentiment is to pick one or two indicators, familiarize yourself with them, and then use them as your tools to help predict where the market is going next. VIX is a commonly used indicator which looks at near term puts and calls. Because it tends to soar when the market is concerned it is commonly called the fear index. The VIX is so heavily relied on that its affects trading so that it can act like a feedback loop as much as an independent indicator.
Do Candlesticks Help Identify and Confirm Market Sentiment?
Japanese Candlesticks are a reliable technical indicator for stocks, futures, options, and currencies. They can be an excellent adjunct to a trader’s arsenal of tools. However, candlesticks look backward at the market in order to predict the next movement. Thus, Japanese Candlesticks are not predictors of market sentiment. They can, however, be used to help confirm movements based on evolving market sentiment. Many traders use an approach in which they find evolving market sentiment indicators and then use tools like Japanese Candlesticks to make certain that they are likely to be placing profitable trades.
How News Events Impact Market Sentiment
The market always looks forward in an attempt to predict where prices are going next and therefore to place trades accordingly. The news can have long term effects on market sentiment or can swing things around overnight. A prediction that a new drug undergoing FDA trials is likely to be a blockbuster will tend to attract interest and gradually drive prices up. An announcement that the drug has passed all FDA trials and is going to be available to the public will have an immediate effect. Many times traders buy on the rumor (sentiment) and sell on the actual news as they believe too much enthusiasm will drive prices up beyond what the market will support over the longer term
How to Check Market Sentiment
Investors and traders who track market sentiment tend to do so on a daily or weekly basis by checking the VIX, CNN’s greed and fear index, or whether safe haven assets or risk on assets are popular. They tend no to dwell on this indicator all day long. Let your assessment of market sentiment help you position yourself for the coming days, weeks, or months and then apply the tools you normally use like technical indicators in your day to day trading.