Market Sentiment: Finding, Analyzing & Understanding Investor Sentiment

When it comes to understanding what investors are thinking, there is no magic crystal ball. However, analysts and market observers often look at various factors to try to gauge the collective mood of those buying and selling securities. This is generally referred to as investor sentiment.

There are a number of ways to measure or analyze sentiment. Some people might use surveys, media analysis or even just good old-fashioned observation. No matter the method, the goal is essentially the same: to get a handle on how bullish or bearish investors are at a given moment.

What is Market Sentiment?

Market sentiment is the prevailing attitude of market participants toward a particular security or financial market. It’s typically quantified as the overall long or short position in the market.

For example, if there are more long positions than short positions, then sentiment is said to be bullish. If the data shows there are more short positions than long ones, then it’s bearish. A ratio of long-to-short positions that’s equal is considered neutral.

Market sentiment can be determined by a number of different methods, but one of the most common is through the use of surveys. Investors, analysts and other market makers are asked their opinion on a particular security or market, and their answers are used to gauge sentiment.

Other methods for measuring market sentiment include media analysis, which looks at the overall tone of articles and other news coverage, as well as good old-fashioned observation.

Bullish Sentiment

A bullish market sentiment indicates that most market participants believe a security or market will rise in price.

This can be due to a number of different factors, such as positive economic news, an increase in corporate earnings or even just a general feeling of optimism. Increased trading volume can be seen as one of multiple contrarian indicators as well as the high-low index or low levels of negative sentiment.

Bullish sentiment is often reflected in the media with more stories focused on the positive aspects of a security or market.

Bearish Sentiment

A bearish market sentiment indicates that most market participants believe a security or market will fall in price. This is the opposite direction of growth and the opposite effect of a bull market.

This can be due to a number of different factors, such as negative economic news, a decrease in corporate earnings or even just a general feeling of pessimism. The greed index and other indicators can also be considered bearish.

Bearish sentiment is reflected in the media with more stories focused on the negative aspects of a security or market. Increased market volatility is also seen as a true indicator of market conditions though it is never an exact science.

Future results help contrarian investors review economic perspectives and sentiment indicators as well as market indicators for financial markets to best understand the implied volatility of the market data as well as how institutional investors are responding to a bearish indicator.

Why is Sentiment Important?

Investor sentiment is important because it can be a leading indicator of future market direction. Investors who are bullish on the market are more likely to buy securities, while those who are bearish are more likely to sell.

As a result, sentiment can be used to predict future market movements. If sentiment is bullish, then prices are likely to rise, while bearish sentiment could foretell a decline. From retail investors to money managers, mutual funds, equity funds and financial analysts the stock market behavior is constantly being reviewed to help maximize trading strategies and improve stock market returns.

Of course, sentiment is not the only factor that determines market direction, but it can be an important one. Retail investor sentiment can also be understood through major message boards, forums and online social media communities such as Reddit, StockTwits and Twitter. As a leading investor relations firm we are constantly reviewing these channels to understand sentiment for our clients.

How to Use Sentiment

There are a few different ways to use sentiment in your investing strategy. One is to simply use it as a market-timing tool. If sentiment is bullish, then you might want to be more aggressive with your investments, while bearish sentiment might warrant a more cautious approach. You can review historical data as well as previous media coverage to find highly correlated daily flows and identify a moving average of daily frequency with strong evidence for an investment.

Another way to use sentiment is to look for contrarian opportunities. This involves buying securities when sentiment is bearish and selling when it’s bullish. The thinking here is that the market is often wrong in the short-term, so by taking the opposite position you might be able to profit. Stock prices often reflect rising prices in the economy and extreme fear for example of recession or a global pandemic can change the general mood driving share prices and stock returns lower.

Of course, using sentiment as a market-timing or contrarian indicator is not without risk. Sentiment can change quickly, and it’s often wrong. As a result, you need to be careful not to get too caught up in the mood of the market and make impulsive decisions.

Understanding Stock Market Sentiment

To get a better handle on what sentiment is and how it might be used, let’s take a look at two examples.

Example 1

The first example involves the stock of Company XYZ. Let’s say that over the past few months, the company has consistently missed earnings estimates and issued weak guidance. The stock price has fallen as a result, and sentiment has become very bearish.

Now, let’s say that you believe the sell-off is overdone and that the company is actually in better shape than the market believes. You might decide to buy the stock, betting that sentiment will eventually turn bullish and the price will rebound.

Example 2

The second example involves the overall stock market. Let’s say that sentiment is very bullish and everyone is talking about how the market is going to continue to go up. You might decide to take a more cautious approach, selling some of your stocks and moving into cash or other safe-haven investments.

Or, you might decide to buy more stocks, betting that the rally has more room to run.

Of course, these are just two examples, and there are endless possibilities when it comes to using sentiment in your investment strategy. The important thing is to be aware of sentiment and how it might impact the market, so that you can make more informed investment decisions.

How Investors Measure Market Sentiment

There are a number of different ways to measure market sentiment including put-call ratios, surveys and media analysis.

Measuring Investor Sentiment Through Put-Call Ratios

One popular way to measure investor sentiment is through what’s known as the put-call ratio. This ratio is simply the number of outstanding put options divided by the number of outstanding call options. A reading above 1.0 indicates more puts than calls, while a reading below 1.0 indicates more calls than puts. This helps determine how many stocks are being bought or sold as options.

Some market observers believe that high put to call ratios can be a bearish sign because it suggests that investors are becoming increasingly worried about a potential decline in stock prices. Conversely, a low put to call ratio might be seen as a bullish sign because it indicates that investors are less worried about a market decline.

Of course, the put-call ratio is just one way to measure sentiment. And like any other technical indicator, it’s not perfect. There are a number of factors that can affect the ratio, including the level of options activity and price fluctuations in the underlying stock prices as well as the overall performance of major indexes like the S&P 500 or the CBOE Volatility Index in addition to closed end funds and mutual fund performance in relation to asset pricing and related terms.

Surveying Investors to Understand Investor Sentiment

Another sentiment indicator and way to measure investor sentiment is through the use of surveys. For example, the American Association of Individual Investors (AAII) conducts a weekly survey to gauge the mood of its members. The AAII investor sentiment survey asks respondents whether they consider themselves bullish, bearish or neutral on the stock market over the next six months.

The results of the survey are then plotted on a graph, with the bull-bear spread representing the difference between the percentage of bullish respondents and the percentage of bearish respondents. A reading above zero indicates more bullish than bearish sentiment, while a reading below zero indicates more bearish than bullish sentiment. The Michigan Consumer Sentiment Index (MCSI) is a monthly survey that gathers information on American consumer expectations regarding the overall economy.

Like the put-call ratio, surveys are just one way to measure sentiment. And like any other indicator, they have their limitations. For example, the AAII Sentiment Survey is voluntary, which means that only a small subset of the investing public participates. The volatility of this alone relies on the participation of responses rather than technical indicators. Economic reports and the volatility index can also assist in understanding sentiment data.

In addition, surveys are often reliant on people’s emotions and memories, which can be unreliable and also don’t always consider asset classes. And finally, it can be difficult to determine whether sentiment is leading the market or vice versa.

Measuring Investor Sentiment Through Media Analysis

A third way to measure investor sentiment is through the use of media analysis. This sentiment indicator looks at the overall tone of the financial media to try to gauge how bullish or bearish investors might be feeling.

Media analysis includes things like counting the number of articles with positive or negative headlines, measuring the tone of articles and looking at the overall coverage of certain topics. Investors want awareness and public relations visibility for their investments, stocks need to constantly be visible and highlighted in a positive light to reduce risk of individual investors losing interest in the stocks.

One popular media analysis tool is the Bloomberg Market Mood Index, which looks at a variety of factors to produce a daily reading on investor sentiment. These factors include things like the number of positive versus negative headlines, the tone of articles and the overall coverage of certain topics.

Like the other methods, media analysis has its limitations. For example, it can be difficult to quantify the tone of an article or to determine whether the media is leading the market or vice versa.

In addition, media analysis tools are often reliant on automated algorithms, which can be fallible.

For example, if the headlines are dominated by stories about market declines and investor anxiety, it’s likely that sentiment is on the bearish side. Conversely, if the headlines are focused on market gains and investor optimism, sentiment is probably bullish.

Like the put-call ratio and surveys, media analysis is just one way to measure sentiment. And as with any other indicator, it has its limitations. For example, the media can sometimes be late to the party when it comes to changes in sentiment. In addition, the media can be biased, which can impact the accuracy of its analysis.

Companies such as Chartcraft publish sentiment indexes that provide investors with a running measurement of market conditions and Chicago Board Options Exchange (CBOE) Volatility Index (VIX Index) is also used as an alternative market sentiment measure.

The Bottom Line

Investor sentiment is a broad term that refers to the collective mood of the investing public. Sentiment can be measured in a number of ways, including the put-call ratio, surveys and media analysis.

Each method has its own strengths and weaknesses, so it’s important to use multiple indicators when trying to gauge sentiment. In addition, it’s important to remember that sentiment is just one piece of the puzzle when it comes to investing.

External factors such as the economy, interest rates and company fundamentals all play a role in the stock market and should be considered when making investment decisions.

One of last things to keep in mind is that, while sentiment can be a helpful tool, it should never be used in isolation. After all, the stock market is a forward-looking mechanism, meaning that what has happened in the past is no guarantee of what will happen in the future.