If you have ever traded or invested or watched the news chances are you have probably heard the term “market sentiment”. This begs the question : what is market sentiment , what does it mean and how can you figure you use it to make better trading decisions using it. Over the next couple paragraphs, these questions will be answered.
We will explore :
- What is a market sentiment,
- The different types of market sentiments
- How to determine the sentiment type
- How to use sentiment to improve your trading
Let’s dive right in.
What is a market sentiment
Market sentiments reflect the collective psychology of market constituents in a given market. This encompasses their expectations, emotions, and opinions about a specific asset, sector, or the market as a whole.
It is important to note, while some markets move one direction differently, correlated markets may move the other direction. I would suggest looking at my article on correlations for more information about this phenomenon [link].
Sentiments are influenced by various factors, including news releases, geopolitical events, investors expectations and psychology. Analyzing market sentiments helps traders gauge the prevailing market outlook and anticipate potential shifts in price trends.
Sentiment types :
Bearish Sentiment: A bearish sentiment occurs when market participants expect prices to decline. It is often associated with pessimism and a belief that the market or a particular asset is overvalued. Bearish sentiments can be triggered by negative economic news, poor corporate earnings, geopolitical tensions, or a general lack of confidence in the market. Traders and investors adopting a bearish sentiment may look for opportunities to sell short, buy put options, or reduce their exposure to the market. Do keep in mind that sentiments have different time frames [link] so do not panic sell at the first sight of a bearish sentiment as it may be very short lived.
A downtrend in the market showing a risk off sentiment in the Crude Oil market.
Bullish Sentiment: Conversely, a bullish sentiment prevails when market participants anticipate rising prices. It is characterized by optimism and confidence in the market or a particular asset. Sometimes this sentiment is called “risk on” and money will flow into risk assets [link]. Thus Bullish sentiments can arise from positive strong corporate earnings, favorable news such as interest rate cuts, or investor optimism. Typically markets are a forward looking mechanism meaning the information in the future will always be of utmost importance on determining the sentiment. Traders adopting a bullish sentiment may seek opportunities to buy long positions, purchase call options, or increase their exposure to the market.
Neutral Sentiment: In contrast to the extreme positions of bearish and bullish sentiments, a neutral sentiment indicates a lack of strong conviction in either direction. This concept is similar to a neutral (or balance) day found in my article about day types [link]. Market participants with a neutral sentiment may believe that current prices adequately reflect the fundamental factors and the market stays rangebound. This can persist for anywhere between days to months where a market stays sandwiched between a high and low price with occasional liquidity grabs [link]. Neutral sentiments can be difficult on traders and investors alike but luckily every neutral markets eventually finds its direction. Traders adopting a neutral sentiment may opt for strategies that capitalize on range-bound market conditions, such as range trading [link] and fading.
rangebound sentiment between 2 prices. Market is not moving much outside of the range high and low.
How to determine market sentiment
Now that we have established market sentiment and why it is important, we need to know how to determine what it is to help us make decisions.
There are many ways to determine market sentiment. As a primary swing trader, I will explain my process:
First off is the overall trend on the market through technical price analysis. This length will vary based on your timeframe and if you are day or swing trading the last 3 weeks should give a good idea. Whereas if you are position trading or investing, the last 3 months will give you a clearer picture. With the past market data and some experience you should be able to know if you are in a trending market regime [link] or a rangebound market [link].
After looking at the past data, the next thing to look at is fundamental news releases. What news is upcoming and what will affect the market. Different asset classes react to different news events. I wrote an article about this that can be found here [link]. Typically the overall stock market gets affected by interest rate news so the federal open market committee (FOMC) will usually be impactful. Other news events such as Non farm payroll (NFP) core inflation and many more will affect sentiment. Typically traders will wait on big news days like FOMC or NFP until after the news before acting making it a neutral sentiment.
Other indexes and measures can help determine sentiment as well. Put/Call Ratio, Volatility Index (VIX), or the Commitment of Traders can be a good gauge of the overall optimism and positioning of various market participants.
Please note there is no clear cut way to determine sentiment and many of these suggestions are based on my years of trading experience. You should always practice to find what works best for your trading style and build your own personalized approach.
Conclusion
Market sentiments significantly influence price movements and provide valuable insights for traders. Understanding the dynamics of bearish, bullish, and neutral sentiments will help you make informed financial decisions. By combining technical analysis, news analysis, sentiment indicators you can navigate the markets with a better understanding of sentiments.
Let me know if there are any other topics you want me to explore and subscribe to our mailing list.
And as always, trade safely !
Cheers,
Andrew Akl
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