3 Most Widely Used Indicators for Measuring Trader Sentiment

Most investors recognize that group psychology performs a huge role in driving the markets. It is no surprise, therefore, that many of the most recognized indicators utilized on Wall St. are those intended to predict shifts in trader psychology.

Sentiment indicators help analysts to understand investor's outlook of the market. Three of the most favored sentiment indicators include the Put-Call Ratio, the VIX and the Bullish versus Bearish Investment Advisor ratio. All 3 of these indicators are used as contrarian studies, which means that they enable traders to recognize when a market has hit an extreme condition and to predict an upcoming reversal. The philosophy for this kind of approach is outlined best by the classic Wall St. adage that the crowd is correct during the trend but wrong at the turns.

Here is more information and facts with regards to each of the 3 main sentiment indicators.

Bull/Bear Investment Advisors
Each week, Investor's Intelligence publishes final results of a opinion poll of investment advisors. This survey tracks whether investment advisors are bullish, bearish, or neutral on the stock market. The Bull/Bear Ratio, consequently, shows the balance between the bullish advisors and bearish advisors. As mentioned, sentiment studies are often employed to identify extremely positive or pessimistic conditions. Severe pessimism on the part of market players (including market advisors) more often than not coincides with market lows, whereas excessive optimism usually coincides with market peaks.

Traditionally, readings above sixty percent have revealed excessive optimism (which is bearish for that stock) and readings below 40 percent have showed extraordinary pessimism (which is bullish for the market).

VIX
Initially presented by Robert Whaley in 1993, the Volatility Index (VIX) is a description of the estimated (or implied) volatility of the S&P 500 for the upcoming thirty days. In the United States, the VIX is made available by the CBOE (Chicago Board Options Exchange) and is frequently referred to as the "fear index" or the "fear gauge." The index is used by S&P 500 investors to ascertain the expected daily fluctuation for the index and market derivatives.

Anytime the VIX attains a high level, it hints that the market is filled with concern. To the contrarian investor, consequently, an exceptionally high VIX level is a bullish indication that the market may soon form a low and a fresh uptrend established. On the flip side, when the VIX is exceptionally reduced, it suggests that the market is currently confident and that a bearish trend-change might be approaching.

Put-Call Ratio
The Put Call Ratio is perhaps the most favored description of investor psychology. The ratio is determined by using the activity of options buyers, who predict market trends within a specific length of time. The most common method of calculating the Put/Call Ratio is to divide the volume of put contracts with the quantity of call contracts exchanged within a set time frame. Traders buying puts are predicting that the market will decline, while speculators buying call contracts are predicting that the market will advance higher. A high Put Call Ratio, therefore, implies that the market is extraordinarily pessimistic, whilst a low Put/Call Ratio suggests that confidence reigns. Again, a contrarian trader will look for extreme situations in either direction to forecast a shift in the tide.

So, there are 3 of the most widely used methods employed to evaluate market sentiment. It ought to be noted that none of these indicators by themselves shapes a well-rounded trading system. They are usually applied in conjunction with additional indicators and studies.