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FEATURE
Gauging Market Sentiment
By Wayne A. Thorp
Sentiment describes the opinions,
emotions or views of a group of people.
In investing, sentiment can be a powerful
determinant of security prices, especially
in the short run. Here, emotions—
whether rational or irrational—can drive
prices. For individual securities, the price
is the sum total of the sentiment of all
market participants. If you could forecast
changes in sentiment, then you should
have an advantage in determining
changes in the market. The problem with
sentiment is that it’s really only known
after-the-fact.
Market sentiment—the summation of
all market expectations—often directly
reflects where the market has been, not
where it is going. When market
sentiment is low, this means that the
majority believes the market will fall,
while high market sentiment means that
the majority feels the market will rise in
value. However, history shows us that
more times than not the market will go
against the majority. Extremely bullish
levels of sentiment often come after
strong market run-ups when investors
are fully invested in the market. Even if
they are bullish about the future, they
have limited additional resources to
invest. By following market sentiment
indicators, you may be able to pick out
market tops and bottoms.
There are different ways in which you
can measure market sentiment—
through surveys of individual and
professional investors, examination of
trading data such as block trades and
short interest, or even looking at the
cover stories of major publications. In
this article, we examine several popular
market sentiment indicators and discuss
how they are normally interpreted and
used in forecasting market levels.
and Market Vane. All except for the
Hulbert market gauge are carried
weekly in Barron’s under Investor
Sentiment Readings in the Market Week
section (Figure 1).
AAII Sentiment Survey: This survey
measures the percentage of individual
investors who are bullish, bearish, and
neutral on the stock market over the
next six months (Figure 2). Originally
started in 1987 as a weekly survey sent
out via mail to a random sample of AAII
members, the survey has been
conducted on-line since 2000. Members
of AAII can vote once a week at the
AAII Web site (www.aaii.com). Results
of the survey are compiled on a weekly
basis (Thursdays) at the AAII Web site
and are published weekly in Barron’s.
Hulbert’s Newsletter Sentiment: Mark
Hulbert, publisher of the Hulbert
Financial Digest, derives newsletter
writers’ opinions on market direction
based on their suggested asset
allocations and the amount invested in
the market. This data is available in the
monthly newsletter, which rates the
performance of advisory newsletters.
Look for the section titled “Market
Exposure Among Market Timers.” The
newsletter is also accessible at the
Hulbert Financial Digest Web site
(www.hulbertdigest.com).
Consensus Index of Bullish Market
Opinion: This index measures the
attitudes and positions of all analysts,
brokers, and investment managers
surveyed by Consensus, Inc. The results
of this survey are published in Barron’s
and can be found at the Consensus, Inc.
Web site (www.consensus-inc.com).
Investors Intelligence: Investors
Intelligence is a newsletter published by
Chartcraft (www.chartcraft.com) that
polls investment advisors and classifies
them as being a bear, bull, or correction.
The survey’s correction number
represents those advisors who are, for
the most part, bullish but believe there
will be some short-term weakness in the
market. The results of this survey are
published weekly in Barron’s.
Figure 1.
Sentiment Surveys in Barron’s
Sentiment Surveys
Several surveys of investor sentiment
are available today. Some of the more
popular are the AAII Sentiment Survey,
the Consensus Index from Consensus,
Inc., Investors Intelligence, Hulbert
Financial Digest’s Newsletter Sentiment,
May/June 2001
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which to use these
values is to compare
Figure 2.
them with historical
AAII Sentiment Survey
levels—if you see the
survey reaching alltime levels for either
bearish or bullish, you
should expect that a
market is probably
nearing a bottom or top,
respectively.
Further complicating
the smart money
argument, however, are
those that believe that
even when the experts
are extremely positive
(or pessimistic) on the
market, we are nearing
a market top (or
bottom). The reasoning
here is that as the
experts become more
positive, the more fully
Market Vane: The Bullish Consensus
they are invested. Therefore, there is
measures the futures market sentiment
less smart money flowing into the
each day by following the trading
market to sustain the upward push in
recommendations
of
leading
security prices. As demand dries up,
commodity trading advisors. It too is
prices will begin to falter. On the other
published in Barron’s or can be found at
side of the coin, when the experts are
the Market Vane Web site
overly pessimistic on the market,
(www.marketvane.net).
chances are they have pulled all of the
money they wish to out of the market.
Interpreting Sentiment Values
As the flow of money out of the market
Perhaps the next logical question
subsides, prices should stabilize—
would be how do you use the values of
forming the market bottom.
sentiment surveys in your investing?
Surveys that poll the general investing
Investors Intelligence, Hulbert,
public, such as the AAII Sentiment
Consensus, and Market Vane poll
Survey, are generally viewed only in a
investment managers, advisors, and
contrarian light. Unlike the smart
professional investors, so their results
money, which is believed to have a better
provide you with the sentiment of the
insight into the goings-on in the market,
“smart money.” The traditional wisdom
the general public is viewed as being
is to trade in the direction of the smart
less informed. They tend to be convinced
money: Professionals may be privy to
of the current trend only after it is firmly
information that the general investing
entrenched. The old saying that once
public is not and, therefore, they make
your barber buys stock the bull market
more-informed buy and sell decisions.
is over applies to this situation—when
When the smart money is feeling bullish,
the least savvy are buying stock, this is
you should be buying and when they
a signal that demand had reached its
are bearish you should sell, or at least
peak. There is no one else to buy.
refrain from buying.
As we know from simple economics,
However, this philosophy can get a
when demand falls or disappears for
little fuzzy when you have to determine
good, the price will inevitably fall.
the levels for “extreme” bullishness and
Therefore, as you see a survey such as
bearishness. Probably the best way in
this becoming more and more bullish,
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you should be on the lookout for a
market downturn. Likewise, if the
participants are becoming increasingly
bearish, you should expect the market
to rise in the near term.
No matter how you use the results of
sentiment surveys, it is important to view
them in the context of the overall market
and economic environment and not in
isolation.
Market Indicators
Beyond conducting polls to gauge
market sentiment directly, you can also
look to trading and market data to gain
insight into the sentiment of the market.
The information used by these indicators
can include short selling, put and call
option trading, odd lot purchases, block
trading, and more.
Odd Lot Balance Index: The OLBI
shows the ratio of odd lot sales volume
to odd lot purchase volume. An “odd
lot” is a stock transaction of less than
100 shares. Transactions of this size are
usually made by the smallest of traders
who are viewed as being the least
informed. For this reason, the OLBI is a
contrarian indicator. When the OLBI is
greater than one, there are more odd lot
sales than buys, and vice versa. Increases
in OLBI value indicate that “odd lotters”
are becoming more bearish, meaning
you should go against this group and
buy. Likewise, as the OLBI falls, the odd
lotters are bullish—this typically
indicates a market high, which means
you should be looking to sell.
The usefulness of the OLBI as a
contrarian indicator has eroded over the
years as large traders have begun placing
trades of less than 100 shares in order to
avoid exchange “up-tick” rules, which
stipulate that specialists can only take
short positions when prices are moving
upward.
Odd Lot Short Ratio: Another
indicator making use of odd lot
transactions is the OLSR. However, it
measures the daily ratio of odd lot short
sales to total odd lot transactions (long
and short). The OLSR has held up better
over time as a contrarian indicator of
market highs and lows. When the OLSR
CI
is rising, the odd lotters are feeling
increasingly bearish—increasing their
number of short sales in proportion to
the total number of odd lot transactions.
A falling OLSR means that less of the
odd lot transactions are short sales. From
a contrarian viewpoint, a rising OLSR
indicates a buying opportunity and a
falling OLSR a selling opportunity.
Bull/Bear Ratio: This indicator is an
adaptation of the Investors Intelligence
survey—the ratio of bullish advisors to
the total number of bullish and bearish
advisors (neutral advisors are ignored).
Illustrating our earlier discussion
regarding sentiment, this indicator tends
to be contrarian in nature. High readings
of the bull/bear ratio are bearish (there
are too many bulls) and low readings
are bullish (there are not enough bulls).
When the bull/bear ratio becomes
extremely high or low, the market has
generally formed a near-term top (high
bull/bear ratio) or bottom (low bull/
bear ratio).
Large Block Ratio: This market
sentiment indicator shows the
relationship between large block trades,
which are trades of more than 10,000
shares, and the total volume on the New
York Stock Exchange. The comparison
of large block trades to total volume
shows how active the large institutional
traders are. The higher the large block
ratio, the more institutional activity is
taking place. A high number of large
block trades in relation to total volume
often coincides with market tops and
bottoms. This occurs as institutions
recognize the extreme overbought or
oversold conditions of the market and
place trades accordingly. This
interpretation of the large block ratio
assumes institutions are in tune with
what is taking place in the market.
value over the preceding four weeks. A
short interest ratio of one means that the
total outstanding short positions are
equivalent to roughly one day’s trading
volume (Figure 3).
A rising market typically follows high
short interest ratios, while low ratios are
generally followed by a declining
market. This is due to the fact that short
sellers have historically been wrong
when it come to forecasting market
direction. A rising short interest ratio
shows that short sellers are becoming
more bearish and a falling ratio is a sign
of increasing bullishness among short
sellers. A second, and perhaps more
compelling, reason for the short interest
ratio’s usefulness as a contrarian
indicator, is because the higher the short
interest, the more shares that must be
bought in order to cover the short trade.
Therefore, the short interest ratio can be
used as a proxy for future demand and
buying.
One note of caution when using the
short interest ratio—it tends to exhibit
monthly seasonality bias. Volume in the
New York Stock Exchange, historically,
has been heaviest during the winter
months and trails off through the
summer months. Short selling tends to
peak in November and December, as
people short sell for tax purposes, and
in January as investors offset covering
transactions.
Member Short Ratio: The MSR
measures the short selling activity of
members of the New York Stock
Exchange (and is the inverse of the public
short ratio, discussed below).
“Members” trade on the floor of the
exchange either for their own account
or for their clients. A high MSR indicates
more member short transactions and a
low MSR translates into less member
short transactions (more member long
transactions). Assuming that the smart
money is indeed smart, which has been
called into question in recent years, you
should be short when the MSR is high
and be long when the MSR is low.
Public Short Ratio: The PSR shows
the relationship between the number of
public short sales and the total number
of short sales. The interpretation of the
PSR assumes that the public does not
know the true direction of the market. If
this is true, then we should buy when
the public is shorting and sell when the
public is long. Historically, this premise
has held true. Generally speaking, the
higher the PSR, the more bearish the
public, and the more likely prices will
increase (given the above premise).
Total Short Ratio: The TSR shows the
percentage of short sales to the total
volume on the New York Stock
Exchange. As with the public short ratio,
the total short ratio takes the contrarian
view that short sellers are usually wrong.
Odd lotters are typically the worst of the
short sellers, but history has shown that
specialists tend to over-short at market
bottoms. High values of the TSR indicate
bearish expectations and low values
indicate bullish expectations. Taking a
contrarian stance, when the TSR is high
Figure 3.
Short Interest Ratio
Short Interest Ratio: This is perhaps
one of the most popular measures of
market sentiment. Short interest is the
number of shares that have been sold
short and not yet repurchased. The short
interest ratio takes the mid-month New
York Stock Exchange short interest and
divides it by the average daily trading
May/June 2001
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opposite direction (Figure 4).
Figure 4.
Put/Call Ratio
we would expect the market to rise.
Likewise, extremely low levels for the
TSR indicate the increased likelihood of
a market decline.
Put/Call Ratio: The put/call indicator
shows the relationship between the
number of puts to calls traded on the
Chicago Board Options Exchange
(CBOE). A call gives an investor the
right to purchase 100 shares of stock at a
pre-determined price. Investors who
purchase calls expect stock prices to rise
in the coming months. Conversely, a
put gives an investor the right to sell 100
shares of stock at a pre-set price.
Investors purchasing puts expect stock
prices to decline.
Because investors who purchase calls
expect the market to rise and investors
who purchase puts expect the market to
decline, the relationship between the
number of puts to calls illustrates the
bullish/bearish expectations of these
investors.
Historically, options investors have
done a poor job of timing market
reversals, as the market tends to move
in the opposite direction as their
sentiment would seem to indicate. For
this reason, the put/call ratio is another
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Volatility Index (VIX): The VIX
measures positive and negative
sentiment as measured by S&P 100
index (OEX) options activity. A rising
VIX indicates that negative sentiment is
growing while rising optimism is
marked by a falling VIX. Historically,
the majority of put/call buyers are
wrong—making the VIX another
contrarian indicator. Therefore, a rising
VIX is an indication that the market is
becoming oversold, meaning a shortterm bottom may be approaching.
Likewise, when the VIX reaches low
levels—the market is overbought—we
can expect a possible short-term top to
the market (Figure 5).
contrarian indicator.
The higher the level of the put/call
ratio, the more bearish these investors
are on the market. Conversely, lower
readings indicate high call volume and
thus bullish expectations. When it
reaches “excessive” levels, the market
usually corrects by moving in the
Stock Margin Debt: This is the total
amount of money owed New York Stock
Exchange members by customers who
have bought stock on margin (borrowed
money). Tracking this data over time is
useful because margin traders tend to
be most overextended at market tops,
while at market bottoms margin
accounts tend to be low. In addition,
margin account activity can have a
measurable impact on market trends.
Increasing stock margin debt tells us
that more people are buying stock, albeit
Figure 5.
The Volatility Index
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on margin. Money flowing into the
market should boost stock prices.
However, if margin debt is falling, this
is an indication that money is flowing
out of the market—people are selling
stock in order to repay the money they
borrowed.
The trend in stock margin debt is more
important than its aggregate value. If
you were to track the level of margin
debt over the last few decades, invariably
you would see an overall increase in the
level of margin debt. However, much of
this is due to the fact that stock prices
and trading volume have increased over
this same period. Therefore, you should
concern yourself with trends and
changes in these trends. When the
amount of stock margin debt is rising,
the odds are favorable that the market is
rising, while a falling level of margin
debt is indicative of a potential market
downturn.
Magazine Cover Indicator
This indicator does not involve polling
figures or market data. Instead, all you
need to do is to go to your local
newsstand and look at the cover stories
of the major magazines. While relatively
obscure and less conclusive in its
usefulness, the “magazine cover
indicator” called the market bottoms of
1969, 1974, and 1990 within a month or
two. This indicator, too, is a contrarian
indicator—if several major publications
are biased in the same direction
regarding the market, then chances are
the trend is firmly entrenched. It may be
so well entrenched, in fact, that it’s
nearing the end and a market reversal is
not far behind. This would bode well
for investors who have been bloodied
by the dramatic turnaround the market
has experienced recently: Over the past
few months, such prominent
publications as Newsweek, Time, and
U.S. News & World Report have all run
cover stories on the fall of the market
and the new bear market. Now, only
time will tell whether this indicator is
marking the coming of an upward
market reversal.
Conclusion
While market sentiment surveys and
indicators may be helpful in predicting
the short-term movement of the market,
they should never be the sole basis for
buy and sell decisions. Furthermore, as
the dynamics of the market change, the
usefulness of these indicators changes
as well. As a result, there are no “hard
and fast” rules you can apply to market
sentiment
indicators.
The
accompanying
box
provides
information on where to find the
surveys and indicators discussed here.
Before you use these sentiment
indicators as part of your investment
strategy, it would pay to do a little
legwork on your own to see how these
indicators have behaved historically as
well as over recent periods. In the end,
you will be a better-informed investor.
Wayne A. Thorp is assistant financial
analyst at AAII.
Where to Find Market Surveys and Indicators
AAII.com
www.aaii.com
AAII members can access the latest results of the weekly
Sentiment Survey in the Member Surveys area under Community.
You can also view results for the past six months and download
a spreadsheet file with data back to 1987.
Barron’s
(800) 544-0422
www.barrons.com
The AAII Sentiment Survey, Consensus Index, Investors
Intelligence, and Market Vane are carried weekly in Barron’s—
look for Investor Sentiment Readings in the Market Week section.
Chicago Board Options Exchange (CBOE)
www.cboe.com
The CBOE Web site offers daily market statistics going back to
1995, open interest on a variety of index options, and volatility
indexes on the Nasdaq100 index (VXN) and index options
(VIX). Visitors can also download historical data files on the VXN
and VIX.
TheStreet.com
www.thestreet.com
At the TSC Metrics section of the Web site, visitors will find a
selection of “sentiment signposts.” The AAII Sentiment Survey
and put/call ratio are both provided for free.
Wall Street Courier
www.wallstreetcourier.com
The Wall Street Courier site offers a broad collection of market
indicators and statistics presented in chart form. Some of the
information provided includes daily call/put ratios for all CBOE
options and CBOE equity options, NYSE short interest ratio, odd
lot/floor trader short sales ratio, specialists/public short sales
ratio, and VIX oscillator. Updated charts, containing the latest
data and five years of data, are only available to subscribers.
Subscribers can also download historical data files for selected
indicators. Subscriptions to the site begin at $15 for one month,
discounted to $40 for six months.
More Information at AAII.com
“A Look at Different Measures of Short-Term
Influences on Prices,” by John Bajkowski, July 2000 AAII
Journal. Locate by using the search tool. Go to Advanced
Keyword Search and select “sentiment measures” from the
keyword box.
May/June 2001
“Short Sales Trading Strategies.” Found in the Stock
Screens area under Specialty Stock Screens. Provides
explanation and performance chart for three stock screens: short
interest ratio, short interest as a percent of outstanding shares,
and largest monthly change in short interest.
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