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There is a commonly known indicator called
"sentiment" analysis. The indicator is based on a
theory that when most people believe the market will
go higher, it usually moves lower, and when most
people anticipate the market to go lower, it usually
moves higher.
Mr. Warren Buffet (the world's most successful
investor) said, "be
fearful when others are greedy and greedy when
others are fearful".
There are a few reasons behind this theory; we
believe the following to be the main factor. We all
know that the underlying reason for any price
movement is due to Supply and Demand, meaning, there
must be additional money to push prices higher and
there must be sellers to push prices lower.
Therefore, when most people believe that the markets
will go higher, common sense dictates that most
people are already "in" or soon will be in the
market, so when even minor bad news comes out there
will a lot more sellers then buyers because of the
diminished money available to the buyers. The same
applies to the up-site, when most people are bearish
and anticipate the market to go lower it is a sign
that the bottom is near, because soon there won't be
too many sellers and lots of money is sitting on the
sidelines to invest. (This indicator can be used in
other markets as well, like Real Estate and
Commodities).
One we know who did benefit from this theory was
Joseph Kennedy, the SEC's first chairman and father
of President John F. Kennedy, he reputedly told
colleagues that "he sold most of his stock prior to
the 1929 Crash after his shoe-shine boy started
giving him tips on stocks". Point being, he realized
that everyone is "in" the market so there is no new
money available to support it.
Now, can we rely on it?
The
fact is that every time before a top in the market
(1987, 2000) there was a lot of optimism, and every
time before a bottom there was a lot of pessimism
(Sep. 2001, Oct. 2002). However, you cannot
make decisions based solely on this indicator,
because many times it does not work. In other words,
the market may go higher even with a lot of optimism
(1999) or may go lower with a lot of pessimism
(2002). And therefore there will be many times when
our signal is in a Buy mode even when there is
optimism out there, and vice versa.
We will measure
sentiment from one to five: 1) being Overly
Pessimistic, 2) Pessimistic, 3) Neutral, 4)
Optimistic and 5) being Overly Optimistic. Remember,
this is a contrarian indicator, the more
optimistic the more bearish for the market it is.
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