The last time Mark Young posted on the Trader’s Blog, he shared his views on a contrarian way of looking at the popular MACD indicator. Today, however, he is writing about something many of us have probably never heard of, “sentiment trading”.
Mark has been an active investor in equity and options markets since 1983, and has been publishing his unique research and trading services since 1992. We hope you enjoy a look at this unique strategy he has developed and leave a comment for him here on the blog. We also encourage you to visit his site, WallStreetSentiment.com.
For much of the past 25 years until recently, with some notable exceptions, “Buy and Hold” has been a challenging benchmark to exceed. While many active investors have “beaten the benchmark” during that period, many investors were or would have been better served by simply taking a passive approach and allowing the market to provide them with historically impressive returns.
I hold, however, that those days are gone, and gone for the foreseeable future. The demographic factors that helped to drive the outsized gains of the 80′s, 90′s, and 00′s are now working against even garnering mediocre long-term gains. To make matters worse, it is looking like the tax policies of the future are likely to become much less favorable to investing, capital formation, and economic growth.
If you agree that we are facing a very challenging investment climate in the years ahead, then you will agree that we need a very robust investment tool-set if we hope to prosper and thrive in the current environment. This is where Sentiment comes in. Over the past several decades, the use of sentiment trading has become more widespread and more sophisticated. I found it to be so useful that I have made it my specialty.
So, in order to survive in a market that has no powerful up-trend, one needs to be able to spot tops and bottoms as quickly as possible, otherwise the moves could be virtually over prior to actual confirmation of a trend change. Sentiment is a big help for this, but there’s a lot of different types of sentiment measure out there. What measures are most useful and how are they used?
Let me say right off the bat that there are a lot of different ways to measure market sentiment and a lot of different approaches to using such. We can’t cover all of them here. I will, however, give you some of my favorites and my general approach, as well as some specific examples and tips.
In my work, I like to look at several different “sentiment sectors”. Not every pool of money looks at the market the same way, but for some reason when any of the three largest “sentiment sectors” get leaning heavily one way, it’s time to look for a possible move in the opposite direction. It is important to note that it is not at all uncommon to have many sentiment indicators in neutral territory while only one sector is calling for a turn. One can be enough to trigger a turn.
Let’s look at the April highs. AAII was showing very benign readings with nearly equal Bulls and Bears. On the other hand, the indicators measuring smaller advisors’ sentiment were heavily Bulled up.
Obviously, this was pretty useful, but it was important to note that some of these measures were pretty Bulled up for quite some time. If these measures are all you are using, you will need to have some form of trend confirmation of a turn unless you can tolerate significant draw downs while you wait. But, there are other sentiment tricks that one might use to fine-tune an entry.
We have found that big, fast jumps in Bullishness or Bearishness often trigger moves in relatively short order. A perusal of our research shows that on 4/23/10, ISEE showed a big jump in Bullishness, which reliably predicted a decline within two days. By Monday night, Hulbert reported a big Bullish shift in the advisors that he tracks and the Tickersense Blogger poll also showed a big Bullish shift. It doesn’t get much better than that. When sentiment shifts hard and fast to the Bullish side of the ledger, it’s usually an emotional call and it’s usually the wrong one, short term. Of course, with the benefit of hindsight, we can see that this would have provided a virtually perfect early entry and just a few days later trend measures would have confirmed a change in trend to the down side.
We pore over these measures every day and look for even more, and we’re constantly looking for new tricks in their use, but adding even a few of these tools to your repertoire can dramatically improve your entries and exits. In a tough market, that can be the difference between survival and thriving.
Mark Young is the publisher of the Wall Street Sentiment Daily and Weekly newsletters. He is also the founder of Traders-Talk.com, an on-line community and resource for traders and investors. You can find out more about his research at www.WallStreetSentiment.com
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