Investor Sentiment: Where Is The Value? – Guest Post

Source: Rebel Traders

Guest post by Dr. Guy M. Lerner of The Technical Take

{Editor’s note: This is part 2 of a multi-part series on investor sentiment}

Investor Sentiment: Where Is The Value?

In part 1 of this series, I put forth the notion that extreme data points, like investor sentiment, don’t always result in a reversion to the mean, but may in fact represent the start of a new trend.  Today, I will tear apart the sentiment indicators even more putting their value into question.

In some respects, investor sentiment is only good if the prevailing opinions of investors are at odds with the current price action.  If prices head lower, we would expect investors to turn bearish, and if prices head higher, investors become euphoric.  Now the bullishness or bearishness may be unfounded, but for the most part investor sentiment tracks the ascent and rise of prices.  Although noteworthy, it is the rare situation where investor sentiment actually deviates from the rise or fall in prices.  This can be seen in the following two examples.

Example 1 shows the “Dumb Money” indicator.  This is the same “Dumb Money” indicator I show every week in our weekly wrap up on investor sentiment.  Overlaying the “Dumb Money” indicator (in black) is a slow stochastic oscillator, which is a measure of the price action, and as you can see, the stochastic pretty much tracks the “Dumb Money” indicator.  For the most part, the stochastic indicator becomes oversold just as investors become bearish (i.e., bull signal).  Price and measures of sentiment are moving together.

Figure 1. “Dumb Money”/ weekly

Example 2 shows a daily chart of the S&P500, and the red line over the chart is the MarketVane bullish percent.  This is another example where the sentiment indicator tracks the price action very nicely.

Figure 2. S&P500 v. MarketVane/ daily

So the question I would ask: where is the value in tracking investor sentiment if the indicators just tracks price movements?

From these examples, it appears that measures of investor sentiment are only a reflection of price movements.  Furthermore, it is the rare situation where price and sentiment actually deviate.  In many respects and as I have presented it here, there is very little value in tracking investor sentiment as you can derive the same information by following price.

So back to our question above: where is the value in tracking investor sentiment?

As we know, investor sentiment comes in several flavors.  We have the “dumb money” and “smart money” and company insiders.  Wouldn’t it be nice to know what the “smart money” is doing while prices are dropping?  Are they buying?  Or selling even more as prices fall?  Price movements are the result of human decisions, and we know that decisions involving money can be highly emotional.  It is well worth knowing what investors, whether they be insiders, professionals or the retail public, are doing with their money.

So after two installments in this series, I have shown that extremes in sentiment don’t always mean revert, and sentiment is just a proxy for the price action.  I have questioned the usefulness of the very tools that I use to help me navigate the markets.  By deconstructing them, I am able to present a better methodology for interpreting the extremes in investor sentiment.  So by the end of this series, I will show you that extremes in investor sentiment do matter even if they don’t always predict the direction of prices.  It is in the extremes of sentiment where prices either mean revert or new trends are born.

Guy M. Lerner, MD has been writing about the markets for over 8 years.  He is the proprietor of the TheTechnicalTake, a free blog dedicated to independent and original market analysis.  He also provides Premium Content newsletter that focuses on investor sentiment in the equity markets.  Lerner is the principal partner in ARL Advisers, LLC, a registered investment advisory in the State of Kentucky.  ARL Advisers, LLC offers a global asset allocation strategy that is strategic balanced, and targeted.

Investor Sentiment: Where Is The Value? – Guest Post is a post from: Rebel Traders – Stock Market and Economic Analysis

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