Sentiment is the psychology of the market: is the crowd optimistic or pessimistic? Extreme sentiment often precedes reversions. When everyone is bullish, lookout for corrections. When everyone is bearish, bottoms emerge. Reading sentiment provides valuable contrarian signals.
Sentiment Indicators
VIX (volatility index) measures fear. High VIX signals capitulation and potential bottoms. Low VIX signals complacency and potential tops. Put/call ratios reveal hedging activity. High put/call ratios indicate defensive positioning and potential bottoms. Bull/bear ratios measure advisor sentiment directly.
Breadth indicators show how broad rallies or declines are. When markets rally but declines outnumber advances, weakness lurks beneath. Divergences between price and breadth predict reversals.
Positioning Analysis
CFTC commitments of traders reports reveal institutional positioning in futures. Extreme positioning (very long or very short) suggests reversals are near. When large speculators are all on one side, contrarians win. Positioning analysis identifies crowded trades vulnerable to unwinding.
Margin data indicates leverage. High margin levels signal overconfidence and potential drawdowns. Rising margin levels during rallies signal increasing risk. Sudden margin declines during declines amplify losses.
Alternative Data for Sentiment
News sentiment analysis measures article tone. Abnormally negative news during declines signals excessive pessimism. Abnormally positive news during rallies signals excessive optimism. NLP techniques extract sentiment from financial news automatically.
Social media sentiment reveals retail investor psychology. Unusual options trading (out-of-money calls, zero-premium strategies) reveals speculative positioning. Volume analysis shows whether rallies have conviction. Declining volume into strength signals weakness ahead.
Contrarian Indicators
Extreme sentiment levels signal reversals. When everyone is bullish at market tops, contrary positions are profitable. When everyone is bearish at bottoms, contrarian positions work. The key: identifying true extremes from normal sentiment variations.
Sentiment works best at extremes. Moderate optimism or pessimism are unreliable signals. Only extreme readings (top 10%, bottom 10%) provide edge. Combining multiple sentiment indicators improves signal reliability by reducing false positives.
Educational content only. Not investment advice.