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5 Sentiment Indicators You Need to Know About
Permabulls always say everyone’s bearish. And permabears always say everyone’s bullish. Most of the time, neither actually gives evidence for their views. That’s why we started T3 Live’s Weekly Sentiment Update. Our Weekly Sentiment Update eliminates opinions, feelings, hunches, and preconceived notions. That lets us strictly focus on the numbers and get a more accurate idea of just how bullish the crowd is. To do this, we take 5 sentiment indicators, break each one down, and then analyze what they mean as a whole. Why 5? Simple — lone sentiment indicators contradict each other all the time. At any given time, one sentiment indicator can read bullish, and another can read bearish. So it’s best to use a variety before forming an opinion. And the 5 we use are all available to the general public without any expensive subscriptions. Here they are, in no particular order: 1) VIX Curve If you understand the basics of the VIX, then you probably know that the VIX alone is useless as a sentiment indicator. And it has little value as a predictor of price. However, by comparing the spot price of the VIX to forward futures prices, you can get an idea of just how much volatility traders are pricing in. For example, if the spot VIX price today is 20 and the 3-month future is 18, that means that traders are pricing in significant short-term volatility. That of course means they’re bearish. Click here for a detailed primer on the VIX Curve 2) CNN Fear & Greed Index The CNN Fear & Greed Index uses a variety of factors including market momentum, junk bond demand, and market volatility to judge whether traders are more fearful (bearish) or greedy (bullish). I’m a big fan of this index because it operates on a simple 0 (extreme fear) to 100 (extreme greed) scale, which eliminates a lot of guesswork. If you’re going to choose only 1 sentiment indicator to follow (which I don’t recommend), this is probably the one to pick because it focuses on actual market activity than polls and surveys. 3) American Association of Individual Investors Sentiment Survey Speaking of surveys, every Thursday, I look forward to the release of the AAII Sentiment Survey. The AAII Sentiment Survey tells us whether individual investors are bullish, bearish, or neutral for the next 6 months. Since individual investors tend to get too bullish at tops and too bearish at bottoms, it’s good to know where they stand. AAII also provides in-depth commentary with its weekly Sentiment Survey data, which is very helpful in making comparisons to historical trends, and in figuring out what’s actually driving public opinion on the market. 4) Chicago Board Options Exchange Equity Put-Call Ratio The CBOE Equity Equity Put-Call Ratio tells us how many put options are traded vs. the number of calls. Reported at the end of each day, the CBOE equity-put call gives us a rough idea of how equity options traders view the market. On average, about 0.65 puts trade for each 1 call every day. When we see major shifts from that long-term average, it can indicate an extreme in sentiment, and a potential trend change in the market. 5) ISE Sentiment Index The ISE Sentiment Index is similar to the CBOE Put-Call ratio, but it has a few interesting twists to it. While many options-derived sentiment indicators are put-call ratios, the ISE Sentiment Index is actually a call-put ratio. The ISE also uses only opening long customer transactions, and eliminates market maker and firm trades. This discards many trades that are not clear bullish or bearish bets from sentiment calculations. For example, shorting puts is actually a bullish trade, and market makers may trade calls and puts strictly to hedge other transactions they make. The ISE also operates on a scale of 100, with 100 representing equal demand for calls and puts. And unlike the CBOE Equity Put-Call, the ISE is reported every 20 minutes on a slight delay. But bizarrely, even tough the ISE Sentiment Index seems better designed, since late December, I’ve found the CBOE Equity Put-Call Ratio more helpful. How You Can You Use Sentiment Indicators in Your Trading Typically, it’s better to buy when sentiment is very bearish, and it’s better to sell when sentiment is very bullish. But you must keep a few things in mind. First, analyzing sentiment is more art than science. Yes, we’re dealing with numbers, but I can tell you from experience that trying to turn them into buy or sell signals through quantitative analysis is extraordinarily difficult. Plus, extremes in sentiment can last quite a long time. For example, as of April 2017, the ISE Sentiment Index has been bearish for months and months. So don’t use sentiment indicators as buy or sell signals on their own. Just treat them as another piece of the puzzle, and incorporate them into your overall market and trend analysis. Let’s take the April 23 French election. After analyzing the 5 sentiment indicators listed above, I determined that traders were very bearish ahead of the news. Traders were clearly pricing in a negative outcome (namely, a victory by far-right populist Marine Le Pen). So if I had wanted to bet on a positive outcome, I would have been encouraged by the bearish sentiment. Why? Because when traders are very negative, positive news can drive huge rallies, which is exactly what we saw on April 24.
Continue Reading -->There Are More Bears Than Bulls Out in the Wild
Permabulls always say everyone’s bearish. And permabears always say everyone’s bullish. Neither side provides evidence for their views. So let’s see how traders are feeling into today’s inauguration: 1) VIX Spread – Bullish The 3-month VIX spread is at +4.51, which indicates traders are pricing in very low near-term volatility. This means traders are bullish. 2) CNN Fear & Greed Index – Neutral The Fear & Greed Index is at 49. F&G operates on a 1-100 scale, and 50 is neutral. So we’re right in the middle. 3) AAII Sentiment – Bearish The latest AAII Sentiment Survey shows that 32.8% of individual investors are bullish, which is below the long-term average of 38.5%. 4) CBOE Equity Put-Call – Bearish The CBOE Equity-Put Call ratio is at 0.71 with a 3-day moving average of 0.74. This indicates higher-than-average bearishness. 5) ISE Sentiment – Bearish The ISE Sentiment Index is at just 79 (79 calls for every 100 puts) this morning – which is a bearish reading. And the 10-day moving average is 81.3. This also indicates bearish sentiment. Conclusion Out of 5 sentiment indicators, we have 1 bullish, 1 neutral, and 3 bearish. I’ve been hearing a lot of chatter about how bullish the crowd is. But if anything, traders are leaning against the market, hoping for a fall.
Continue Reading -->Bears Scream After the Donald Trump Bump
The ISE Sentiment Index is one of my favorite sentiment measures. It is a call-put ratio (as opposed to a put-call ratio) that uses opening long customer options transactions to judge sentiment. It excludes trades like short puts (which are bullish positions) and trades from market makers and firms, which to me makes it more useful than straight put-call ratios. As of yesterday’s close, the ISE’s 10 day moving average was just 67. That is an all-time low, and it’s likely to go even lower tomorrow. As of 10:30 a.m. ET, the ISE was at just 44. If it closes at 44, the 10-day moving average will be down to 66. Over time, the ISE has fallen as equity options have increased in popularity as a hedging instrument, even for credit investors looking for protection in illiquid assets like high-yield bonds. But still, this is a pretty depressed reading. It’s lower than readings seen at the August 24, 2015 mini-crash. And prior to this 10-day stretch, the ISE averaged 87 this year. And the 10-day moving average bottomed at 76 during the February mess. In my experience, when you have technically stretched markets and bearish sentiment, we tend to see a stalemate. That said, other sentiment indicators I follow like the CNN Fear/Greed Index and AAII Sentiment paint a slightly different picture. But after the 2-day Trump bump, it’s safe to say fear is setting in again. Check out this chart of the S&P 500 against the ISE Sentiment Index: As you can see, when the ISE gets to these depressed levels, the market tends to bounce. However, we’re in uncharted waters from a political standpoint, and it still feels like we’re in an “anything goes” environment.
Continue Reading -->Newsflash: This Stock Market Is Not Loved
Permabulls always say everyone’s bearish. And permabears always say everyone’s bullish. Neither side likes to provide evidence for their views. So I regularly run through a wide variety of sentiment measures to get a realistic reflection of the market’s mood. According to 7 sentiment measures I track, traders are slightly bearish, even though we’re within 1% of the all-time SPX high. Let’s go through them one by one: 1) SPX Options Prices – Bearish SPX options prices show a high put skew. I looked at 10% out-of-the money 6-month SPX options. There is currently a 10 point skew on the puts, which is the 98th percentile for the past 5 years. So relative to calls, traders are paying more for 10% OTM 6 month puts than they have 98% of the time over the past 5 years. 2) ISE Sentiment – Bearish The ISE Sentiment Index closed at just 63 yesterday (63 puts for every 100 calls). And its 10-day moving average is just 81.1 — a level that indicates bearishness. Markets tend to overheat with 10-day MA readings well over 100, so we’re not even close to that. 3) AAII Sentiment – Bearish The latest AAII Sentiment Survey shows that 24.8% of individual investors are bullish. This is well below the long-term average of 38.4%, and below the 2016 YTD average of 28.1%. Bearish sentiment is at 38.3%, the highest it’s been since the February 11 bottom, when it spiked to 48.7%. 4) Investors Intelligence – Neutral Yesterday, the Investors Intelligence Survey of newsletter writers showed the 4th straight decline in bullishness with a drop to 44.6% bullish from 49% last week. Bears are at a 10-week high at 24.3%. 5) CBOE Equity Put-Call – Neutral The CBOE Equity-Put Call ratio was 0.63 yesterday, which is above the YTD average of 0.5, and right in-line with the 5-year average of 0.65. This points to neutral sentiment. 6) CNN Fear & Greed Index – Bullish The Fear & Greed Index is at 61, which is modestly in the ‘Greed’ category. F&G operates on a 1-100 scale, and 50 is neutral) 7) Wall Street Strategists – Bullish The average year-end 2017 target price for the S&P 500 is 2391.44, according to Bloomberg. This implies a 9.7% gain from here — basically in-line with historic stock market averages. ********* So we have 3 bearish indicators, 2 neutral indicators, and 2 bullish indicators. Blend them together and you have a slightly bearish crowd. I’m hearing a lot of bears saying that everyone’s complacent… but I just don’t see it. P.S. Interested in prop trading? Sign up for today’s FREE webinar and find out if a prop career makes sense for you.
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