The financial market is the driving force behind the global economy. On a daily basis, companies and other institutions are taking credit, issuing shares, announcing results, and doing large mergers and acquisitions.
This movement in capital opens an opportunity to traders around the world.
For instance, when beer manufacturing giant, AB Inbev, announced its planned acquisition of Sab Miller for $107 billion the pound strengthened because it would be the transaction currency.
Though the deal would materialize months later, the market sentiment was positive for the cable.
Another example is in the oil market. In 2016, oil has recovered significantly. The recovery has not been driven by the fundamental fact that supply is reducing or the demand is increasing.
The primary driver of the current oil price is sentiment! Traders believe that oil has already bottomed and the resistance line cannot be broken.
Here are a few strategies successful sentiment traders use to profit from the market.
1. Social Media
Social media has changed how things are done today. Companies such as Facebook and Twitter are now very influential in the financial market. In fact, they are now more useful for traders than the traditional media channels such as Wall Street Journal and Financial Times.
This is why we made a post with the best account to follow on twitter.
In many times, the traditional media has been forced to write news after it broke in social media.
Another very important social media tool is StockTwits which is like Twitter but for the investment community.
As a sentiment trader, you need to constantly be on the lookout for what is happening in the social media. In 2013, a hacker hacked AP and reported that there was an explosion in White House and that the president was injured. This news led to a major market move in favour of the bears despite the fact that it was not true.
Therefore, as a trader, you need to look at social media before making any trading decision.
2. CBOE Volatility Index
CBOE Volatility Index, also known as the VIX is one of the most important sentimental analysis tools. It is also known as the fear index. The VIX measures the amount of volatility in the financial market.
It accomplishes this by measuring the amount of investor protection within the next 30 days.
For instance, if there is a major economic or financial news, chances are that the VIX figure will go up.
A good case in point happen during the Brexit vote. Before the vote, the VIX shot up from 15 to 20 in two trading days. In a normal situation, when there is such a move in the VIX, the result is that the S&P would move up by 3-4%. It moved by just 1.7%, which is an indication of the fear the investors had.
After the vote, the VIX was up to 25 which is an indication of the fear the investors had. Therefore, to be good at sentimental analysis, you should always refer to the VIX before making any entry or exit decision.
3. High/Low Sentiment Ratio
This is a very important tool that will help you make an informed trading decision. It is particularly important among traders who specialize on equities.
On a daily basis, a number of stocks will hit their 52-day high and lows. This indicator compares the number of stocks making their 52-day high and those making their 52-day low. If more stocks are in the high zone, it means that the market is bullish.
On the other hand, if more stocks are hitting their 52-day low, it means that the market is bearish.
As a sentiment trader, this information can help you make informed decision.
4. NYSE Bullish Percentage
As the name suggests, NBP measures the percentage of companies that have a bullish pattern in the New York Stocks Exchange (NYSE). This number is established by technical analysis on point and figure graphs.
Normally, the percentage is in the range of 40 and 60%. This is because in a normal market environment, there will always be companies that are doing well and others not doing well. When this number goes very high (>80%), it is an indication of an overbought market.
When it goes very low below 20%, it is an indication of an oversold market.
5. Fear and Greed Index
The fear and greed index is one of the most popular sentiment trackers in the financial market. The index, which was developed by CNN Money, is widely used to show whether there is fear and greed in the financial market.
It does this by looking at several aspects of the financial market. For example, it looks at the stock price strength, where it looks at the number of stocks hitting their 52-week highs. It also looks at the stock price breadth, using the McClellan Volume Summation index.
Other major constituents of the fear and greed index are the put and call options, market momentum, junk bond demand, market volatility, and safe haven demand.
The fear and greed index ranges between zero and 100. When it is close to zero, like it was during the 2020 stock market crash, it is usually a sign that the market is extremely fearful. A level close to 100 is a sign that the market is extremely greedy, and is often a sign to sell.
6. Buffett Indicator
Another popular type of sentiment measurement is the so-called Buffett indicator. It is usually associated with Warren Buffett, who is one of the best-known investors in the market. It is usually a ratio of the US stock market valuation compared to the total GDP.
As of this writing (end of 2020), the US has a total GDP of about $21 trillion while the total market cap of all public stocks is $45 trillion. This means that the Buffett indicator is 203%, which is 72% higher than the historical average.
The chart below shows the Nasdaq 100 index together with the Buffett Indicator.
Having a good understanding of market sentiment is an excellent thing for most traders. For example, knowing where the VIX is can tell you what to buy or sell. The same is true with other tools like the fear and greed index and the NYSE bullish percentage.
Before you use them, we recommend that you spend a few days in a demo account to see how they work.