TLDR — See our Fear and Greed Index here.
Just yesterday, a fake photograph of an explosion near the Pentagon spread like wildfire across social networks, briefly sending stocks lower in what was the first market movement caused by an AI-generated image.
While this certainly lends itself to the discussion of how AI may need to somehow be regulated—we also think it leads to a different discussion—which is around how market sentiment can drive markets.
Events like this remind us that markets are not completely rational, because—well, humans are not completely rational.
Even the most logical of human beings amongst us are susceptible to having their higher reasoning overridden if there is enough of an emotional stimulus present.
Markets can move on fear and greed alone, so it makes sense for us to make monitoring them part of a holistic strategy when we are choosing what to invest in and when.
"Be greedy when other are fearful, and fearful when others are greedy."- Warren Buffett
In today's post, we're going to discuss how market sentiment is traditionally measured, as well as how we present market sentiment as part of the Synvestable platform—with an AI twist.
Traditional Indicators of Market Sentiment
Measuring market sentiment is nothing new. First, we'll go over the traditional forms investors have used in the past to try to gauge market sentiment, as well as their limitations:
The VIX, often referred to as the fear index, is a widely-used indicator for analyzing market sentiment. It is based on the CBOE Volatility Index, which tracks options prices and expected volatility over the next 30 days. By observing the movements of the VIX, investors can gain insights into the expected conditions in the near future.
Although the mechanics of this index can be complex, the implications of the VIX's movements are relatively straightforward. For instance, an increasing VIX suggests a need for investors to protect themselves against higher risks caused by greater volatility.
Conversely, a lower VIX indicates lower levels of volatility. However, it's important to note that the VIX does not provide information about the direction of the markets; its primary function is to track volatility.
Bullish Percent Index
Another indicator of market sentiment is the bullish percent index (BPI), which monitors the number of stocks exhibiting bullish patterns.
When the BPI exceeds 80%, it indicates extreme optimism in the markets, suggesting that stocks may be overvalued. Conversely, a BPI below 20% suggests a predominantly negative sentiment and the possibility of undervalued stocks.
The High-Low Index
The High-Low Index is another useful tool for understanding market sentiment. It compares the number of stocks reaching 52-week highs to those hitting 52-week lows within a specific index, such as the S&P 500 or Nasdaq.
A value below 30 on this index suggests a bearish sentiment, while a value of 70 or higher indicates a more bullish outlook among investors.
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Commitment of Traders Report
The Commitment of Traders Report (COT) is yet another traditionally used indicator for assessing investor sentiment.
It focuses on commodity traders and reports the futures holdings of a selected group of these professionals. Contrarian investors often utilize this report to analyze the prevailing sentiment in the markets.
Moving averages are also relied upon by many investors as a means of gauging market sentiment.
The two commonly used moving averages are the 50-day simple moving average and the 200-day simple moving average.
As a general guideline, when the 50-day average surpasses the 200-day average, it suggests a shift towards positive sentiment and a bullish outlook.
Conversely, if the 50-day average falls below the 200-day average, it indicates bearish sentiment and declining prices in the markets.
Limitations of Traditional Measures
One of the biggest limitations of all these measures is that none of them take into consideration safe-haven asset demand.
In order to truly measure market sentiment for stocks, you need to understand how demand has shifted to alternative safer assets such as bonds.
Another limitation of traditional measures is that they do not consider investor appetite for junk bonds, which is an indicator as to how much investors are chasing returns as well as their risk appetite based on perceived equity returns.
Junk bonds are issuers of credit that have a higher likelihood of default—the expected return on the bond will compensate for the additional risk, which is indicative as how how "return-hungry" the overall market is outside of the equities markets.
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The last limitation is that all of these traditional measures measure just one or two aspects of the market in a vacuum.
The VIX measures volatility anticipated extreme moves from the derivatives market...and moving averages in a measure of investors expected momentum continuation.
But the VIX tells you nothing about momentum...and moving averages won't tell you much about anticipated large moves.
Luckily, there's an indicator that combines all of these measures of market sentiment into a simple, easy-to-read indicator—from momentum, expected extreme moves, safe-haven demand, and junk bond demand—to price breadth and overall price range movements.
Enter the Fear and Greed Index...
The Fear And Greed Index
The Fear and Greed Index is a tool used to measure investor sentiment in financial markets.
It combines all of the traditional measures of market sentiment we described above, along with some other ones we didn't mention, such as put/call ratio.
At its most basic level, the index works by measuring how much traders are willing to pay for assets like stocks and commodities, relative to the average price over recent periods.
The Fear and Greed Index works by measuring how much investors are willing to pay for assets, relative to the average price over recent periods.
When prices rise faster than usual (indicating "greed"), then it indicates high levels of risk taking as people feel more positive about future growth prospects.
Conversely, when prices fall faster than normal ("fear") this shows that there may be panicked selling due to negativity or worry.
The scale ranges from 0-100 with low numbers corresponding to very bearish sentiment (everyone is selling), while higher numbers indicate exuberance or irrational optimism among investors and buyers of assets.
As such Fear and Greed Index helps investors have a more well-rounded metric towards whether now is the time to contrarian or not.
Fear And Greed Index Limitations
It's important to note that like any market sentiment indicator, the Fear and Greed Index has its limitations.
For example, the Fear and Greed Index is measuring quantitative factors only, meaning that sentiment is scored based on price history and measurable demand factors only.
It does not take into consideration things like news sentiment.
Luckily, we have a solution for that too!
Synvestable's Approach To Market Sentiment
This is why on our Market Page, we approach market sentiment a bit different that allows both premium and free-registered users to analyze market sentiment using a variety of factors.
The VIX from our view helps investors measure overall expected market volatility.
Sometimes fear and greed is sector-based and not within the overall market. For that reason, Sector Performance helps us determine if certain sectors are falling out of favor due to sector-specific news or economics.
Fear and Greed Index
The Fear and Greed Index helps measure all quantitative market sentiment factors, outside of news sentiment. This is a holistic overall measure of market sentiment.
Market News Sentiment
The Market News Sentiment Indicator uses natural language processing (NLP)—a form of artificial intelligence—to measure the sentiment of incoming news headlines and articles for the day.
We also provide this indicator on company-specific news on every company page.
Putting It All Together
Market sentiment alone shouldn't be the sole reason for buying or selling assets, however if you are considering buying or selling assets as part of long-term investing strategy, the market sentiment indicators on the Market Page can help you holistically determine if now is the best time to be buying or selling.
Emotions alone can certainly move markets, however they don't have to move you.
Using our market sentiment indicators in conjunction with sound portfolio allocation strategies based on valuation, style, and price targets can help you better determine if now is the time to be contrarian fearful or greedy.
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