I discuss sentiment every couple of months on the blog. Most recently I wrote about the proprietary sentiment indicator developed by Ned Davis which is hitting historical extremes. However, single pieces of sentiment data are not the end all be all for trading.
Phil Pearlman is an excellent blogger and is the editor of StockTwits. Phil often shares great insight into behavioral finance and market psychology. Today Phil wrote a piece discussing that no single sentiment indicator or data set is perfect…..
Its impossible to precisely measure market sentiment.
Compare it to measuring market behavior.
There is only one way to measure market behavior but we can do that with total precision. Look at a chart and we know the high, low and close over multiple time frames and also the exact amount of that behavior or volume.
Now, lets think about sentiment for a moment.
We have multiple ways to purportedly measure it (put/call, $VIX, AAII, anecdote etc) and yet none of these methods are precise. Sentiment is an internal process and even one individual can only inexactly verbalize a feeling much less tens of thousands of individuals. There are construct limitations too as all of these measures are not actually measuring sentiment itself but only a shadow of it (implied volatility etc).
This is a great point. We’ve seen various pieces of sentiment data spike throughout 2013, all of which have been crushed by the bulls as equities marched higher. While there isn’t a single sentiment data set that can lead the way in a vacuum, it still can be a useful tool in measuring the ‘health’ of the market. We can’t forget that while the stock market is in fact a market of stocks, it’s also a market of emotions.
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