There Are Many Ways to Skin a Sentimental Cat

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.

Source: The Difficulties of Measuring Sentiment (Phil Pearlman)

Disclaimer: Do not construe anything written in this post or this blog in its entirety as a recommendation, research, or an offer to buy or sell any securities. Everything in this post is meant for educational and entertainment purposes only. I or my affiliates may hold positions in securities mentioned in the blog. Please see my Disclosure page for full disclaimer. Connect with Andrew on Google+, Twitter, and StockTwits.

Fearful Traders Send Put Buying to Lofty Levels

Just three days of weakness with Friday being one of the lowest volume trading days of the year and traders are still shaking in their custom-made boots. Over the last few days we’ve seen a pick up in put buying as fear pours into the market.

Below is a chart of the S&P 500 ($SPX) and the three breakdowns of the put/call ratio. First we have index options, then equity options, and all options. Index put/call and all options put/call are both at extended levels as a surge in buying of puts has pushed the ratios off-balance. This type of data can help give us an idea of market sentiment. As more puts are purchased it typically signals more fear entering the market – sometimes too much fear.

put callBased on the strength of equity futures this morning, it looks like we are in for a pop – although still plenty of trading to be done. Last week I discussed whether the bout of weakness we were experiencing was a sign of a top or just the markets taking a breather. I put my ballot in the latter, guessing that we would see some continued strength as bulls buy the dip, and that appears to be taking place this morning.

Market participants appear jittery, fearful to have equity exposure but still nervous of missing out on any rally attempts. It’s important to stay focused and not get lost in the minutia. Create a plan and follow it and there’s a good chance you live to fight another day.

Disclaimer: Do not construe anything written in this post or this blog in its entirety as a recommendation, research, or an offer to buy or sell any securities. Everything in this post is meant for educational and entertainment purposes only. I or my affiliates may hold positions in securities mentioned in the blog. Please see my Disclosure page for full disclaimer. Connect with Andrew on Google+, Twitter, and StockTwits.

Equities Just Taking A Breath or a Market Top?

It’s amazing how fast sentiment can change. Yesterday morning my twitter feed was full of bulls kicking the bears in the grown but once they came back from lunch those same instigators had put on their bear suits and where calling for mass panic. Amazing.

The move in equities has been described as parabolic and Fed-induced. But I must ask – who cares? We have/had an uptrend and that’s what matters. We can monitor market internals to get an idea of how healthy the move has been and how long in the tooth it may be.

But now that we’ve had what looks like the second down day in a row people are freaking out. So is this just equities taking a breather or have we put in a market top?

First lets look at the move that’s taken place. No one will argue its been unusual for equities to march this high this fast. In fact, going back to 1998, we have only seen equities this extended four previous times. The chart below shows the S&P 500 ($SPX) in relation to it’s upper and lower Bollinger Bands on a weekly basis. Three of the past four instances we have been this far above the upper band has led to a correction, with 2004 being the exception. So yes, it seems it would be healthy for the market to experience some type of down move or consolidation but we can’t be naive in assuming that because we are high in the clouds that the plane must crash.

Looking at the short-term view of momentum, we are already oversold based on certain metrics. I wouldn’t be surprised if traders view this recent bout of weakness as a buy-able dip. That’s what they have done with each of the drops we’ve experienced so far this year and muscle memory is likely to still be fresh. BB SPX

It’s not my job to make predictions, it’s much easier to let the tape lead the way and allow price action to dictate my reactions. However, if I were to make a prognostication then my guess would be that buyers step in and take us to a fresh high. Not saying it happens today or tomorrow (although it could!) but that bulls take another whack at keeping risky assets in play. This could give us the opportunity to put in some negative divergences and see some of the ‘risk on’ components of the market stumble in relative performance.

Earlier this week I mentioned the extreme in sentiment from Ned Davis Research’s report. We have the building blocks for a correction, it’s just a matter of when the players deem them important. If anything has been apparent in 2013 it’s been that being a equity bear has not been fashionable. I have not put on my bear hat just yet but it may be time to dig it out of the closet.

Disclaimer: Do not construe anything written in this post or this blog in its entirety as a recommendation, research, or an offer to buy or sell any securities. Everything in this post is meant for educational and entertainment purposes only. I or my affiliates may hold positions in securities mentioned in the blog. Please see my Disclosure page for full disclaimer. Connect with Andrew on Google+, Twitter, and StockTwits.