Market Sentiment: Definition, Indicator, Types, Examples

Have you ever heard about market sentiment? Market sentiment is one of the commonly used terms in the stock market world. Investors and traders keep a keen eye on the daily activities that usually influence the market sentiment. They often search for questions like "What is market sentiment today?” or inquire about global market sentiment. Let us dive deep into understanding market sentiments, types of market sentiments, market sentiment indicators, and more in detail. Keep reading!

What is Market Sentiment?

Market sentiment is an indicator that describes how the market is feeling or the overall attitude of traders and investors toward the market. The sentiment can be related to a specific stock, a sector, or the entire market.

Market sentiments can be positive (bullish), negative (bearish), or neutral, and they can be influenced by factors like economic indicators, company news, broader global events, and political events.  Understanding the market sentiments along with a proper market study helps you make an informed decision of whether to buy, sell, or hold your stocks.

Types of Market Sentiments

Due to technical tools and price patterns, market sentiment is often ignored, but neglecting it can prove expensive. As a trader and investor, every sentiment is important to understand the stock market better. Let us look at the different types of market sentiments.

Positive Market Sentiment

When people feel positive about the economy and the stock market. It creates a positive market sentiment, making others want to invest more in the stock market. This can potentially raise prices and start a bull market.

Negative Market Sentiment

During economic uncertainties, investors anticipate a drop in stock prices, creating a negative market sentiment. In such a situation, people tend to focus on selling their stocks resulting in significant price decreases and reduced demand.

Neutral Market Sentiment

Neutral market sentiment lies between optimism and pessimism. It happens when investors are not sure about the market’s direction, like whether the stock prices will rise or fall. During such situations, the market may experience consolidation periods or stay within a specific price range.

How does Market Sentiment impact prices?

Market sentiments affect prices by impacting demand and supply. Traders look at sentiment indicators and various other analyses to make a better decision about when to buy and sell. To maximize returns, investors need to correctly understand what people are feeling about the market and act swiftly.

Behavioral Finance Theory

Pioneered by Kahneman & Tversky, behavioral finance theory helps in understanding the irrational financial behavior of investors. Cognitive biases and limited self-control such as reliance on heuristics for allocation and overconfidence in forecasting notably shape their market behavior, and excessive reliance on past performance often leads to biased investment choices. The behavioral finance theory indicates that investors often deviate from their decisions and are influenced by personal perceptions or the actions of fellow investors.

Animal Spirit Theory

Formulated by John Maynard Keynes, animal spirit theory refers to the ways human emotions impact financial decision-making in uncertain and volatile situations. The situation can be during market upswings or market declines. During the market upswing, investors are drawn to optimistic expectations and allocate their portfolios accordingly. On the other hand, if the market declines, investors often become negative but still hold onto risky portfolios to prevent acknowledging losses. This behavior is referred to as herd mentality. It is strongly linked to market sentiment and can lead to irrational exuberance, often causing inefficient pricing and bubbles.

Different Market Sentiment Indicators

Below are some of the market sentiment indicators providing insights into how investors feel about the market and its potential direction:

Volatility Index (VIX)

The Volatility Index (VIX) is a sentiment indicator to predict market volatility for the upcoming months. It is calculated from option prices and implied volatility. A higher VIX indicates more expected volatility.

High-Low Index

The High-Low Index counts the number of stocks hitting 52-week highs or 52-week lows. It is considered bearish if 30 or more are at lows, whereas if 70 or more are at highs, it is considered bullish.

Advance-Decline Line (ADL)

The advance-decline line (ADL) helps in keeping track of how many stocks are going up against how many are going down. If more stocks are moving upwards, ADL suggests people are feeling positive, and if there is a downward trend, it indicates people are feeling negative about the market.

CoT (Commitment of Traders) Report

The CoT (Commitment of Traders) report is used by many community traders to predict future prices. These traders often take actions that are contrary to the majority.  

Bullish Percent Index (BPI)

The bullish percent index (BPI) reflects the percentage of stocks exhibiting bullish patterns within a specific index. It is a bull market if the pattern is more than 80% bullish and it is a bear market if the pattern is 20 or below bullish.

Moving Averages

Moving averages analyze the price movement of a specific stock or stock index over a set period. It calculates the average price over 50 or 200 days. If the 50-day average is higher than the 200-day average, it indicates a bearish trend, and vice versa.

Put-Call Ratio

It tracks the amount of put options traded compared to call options. When the ratio is high, it usually means people are feeling bearish, while a low ratio suggests bullishness.

Conclusion
Emotions and perceptions are two of the driving forces of the market sentiments. From day-to-day traders to long-term investors, market sentiments highly impact investors’ decisions, helping them to identify market opportunities. Market sentiments can be evaluated by various methods to predict significant market changes. It is important to use these market sentiments along with other trading strategies to make a valuable improvement in your analysis of market trends.