Market sentiment refers to the all around attitude investors have with regards to a certain financial market or specific security. It is the tone and feeling in a market. This is displayed via the price movement and activity of various securities which trade in a given market. Some have called it the market crowd psychology or investor sentiment. Rising prices in a market are indicative of bullish market sentiment, while declining prices indicate the sentiment in a market is bearish.
What makes market sentiment so interesting is that it is sometimes not based on the underlying fundamentals of the security or market in question. At times it instead is based on emotion and greed rather than actual business valuations and fundamentals.
This market sentiment matters immensely to both technical analysts and to day traders. These individuals read technical indicators in order to measure shorter term price movements which the attitudes of investors can cause in a given security. They attempt to profit from these price fluctuations. Such sentiment also is important for contrarian investors. They prefer to place trades in the opposite direction of any prevailing sentiment. When all other investors are buying, a contrarian will use this sentiment to instead sell.
In general, market sentiment is referred to as either bullish or bearish. As the bulls have control, the stock prices are running up and away. As the bears are dominant, prices of stocks are declining or even plunging. Since the markets are subject to and driven from the emotion of the collective traders, the sentiment of the markets is often not correlated to the underlying fundamental values. This means that market sentiment is more about group emotions and feelings while the fundamental value is more about the actual business performance.
Traders realize profits when they find those stocks which are either undervalued or overvalued because of their market sentiment. Traders and investors alike utilize different indicators to attempt to ascertain what the sentiment of the markets actually is. This helps them to decide which stocks are the best ones for them to trade. There are a number of these helpful indicators. Among the more popular ones are the following: VIX CBOE Volatility Index, Bullish Percentage, 52 Weeks High to Low Sentiment Ratio, 200 Days Moving Average, and 50 Days Moving Average.
The Fear Index, or VIX, runs off of the option prices. Such options prove to be like insurance contracts. A rise in the VIX means that traders see the need for more insurance within the markets. When traders instead feel like there should be more risk, this reveals a greater amount of price movement. Traders can simply compare the present VIX against the historical moving averages of it to decide if it is actually lower or higher.
Bullish Percentage quantifies the numbers of stocks that have bullish patterns. It relies on point and figure charts to do this. Typical markets will demonstrate a 50 percent bullish percentage. If the figure turns out to be at least 80 percent or greater than this, then the sentiment of the markets is highly bullish. Another way of saying this is that the market is actually overbought. Similarly if the figure is 20 percent or less than this amount, it signals the sentiment of the market is bearish. This makes it oversold. Traders can simply sell as the market is too overbought and buy as the markets are oversold.
High To Low Sentiment indicators will take the stocks which have made 52 week long highs and compare these against those stocks which have just made 52 week long lows. If stock prices trade around the lows universally, then the trading community is bearish in its sentiment on the markets. Conversely, if the stock prices trade near or at their highs, the same traders are instead showing their bullish market sentiments.