Today we are going to focus on the Sentiment Analysis. There are three main types of analysis that traders, analysts, and investors use. The first one is fundamental analysis, the second one is technical analysis and the third one is sentiment analysis.
Market Sentiment refers to the overall attitude of the investor and the way they behave in the market. It can be viewed as the market’s crowd psychology as showed from the price movement of securities. In broad terms, the bullish market sentiment is when the market has a rise in prices. On the other hand, bearish market sentiment is when the market has a fall in prices.
Sentiment Analysis can be called investors sentiment due to the amount of sentiment influence put-on assets. Their reactions do not always follow fundamentals which is why day traders most of the time will depend on the sentiment in the market since it can also influence the technical indicators that they will use. Day traders can benefit from short-term profits when price movements are happening according to investors’ attitudes. Sentiment analysis can also help traders who like to trade in the opposite direction of the prevailing consensus. For example, if everyone is buying this trader will sell and vice versa.
The most common terms used to describe a sentiment market is bullish or bearish. When sell traders are in control, meaning they exceed buyers the stock price will go down. If buy traders are in control the stock price will go up. Emotions are a very often driver of the stock market, therefore sentiment is not the same as fundamental. Sentiment market has to do with the feeling and emotion of traders and investors whereas fundamental analysis has to do with a company’s overall performance.
There are many traders or investors out there that are willing to make decisions based on market sentiment. For example, they can identify overvalued and oversold stocks. In order to do that they need to use different indicators to measure market sentiment. The most widely used indicators are:
The VIX, also known as the fear index, is driven by options prices. A rising VIX means an increased need for reassurance in the market. Traders that feel the need to protect themselves from potential risks will use it to identify increased volatility. Traders with a low-risk appetite will use it as an indicator to move away from the market. Moreover, VIX users add moving averages to determine how high or low the VIX is.
A high-low Index is a tool for comparison between the number of stocks making 52-week highs and 52-week lows. When the high-low index is below 30, the stock price is usually near to their low values. On the other hand, when the index is above 70 it is a sign that the stock or asset is traded near its high values. Above 70, gives a bullish sentiment to investors, whereas below 30 gives them a bearish sentiment. This indicator is usually applied to indices rather than stocks. Such as the S&P 500 or Nasdaq, etc.
The bullish percent index is a measure of the bullish stock’s patterns based on charts. Whenever the BPI is over 80% it is an indication of a very optimistic/bullish market that most of the time could be overbought. When the BPI is less than 20% it is an indication of a very negative mood and shows an oversold situation. A neutral market will have a BPI of around 50%.
Moving averages are mostly part of the technical analysis. You can click the header above, and you will see the full explanation. However, moving averages can be used to determine the market’s sentiment.
Investors that use moving averages to identify the market sentiment will use a 50-day simple moving average (SMA) and 200-day SMA. When the 50-day SMA goes above the 200-day SMA it forms a golden “cross”. This shows that the momentum is shifting towards the upside of the chart and gives a bullish sentiment. When the 50-day SMA crosses below the 200-day SMA it forms the “death cross”. This will show a shift on the downside of the chart giving a bearish sentiment.
Each trader and investor have his own opinion about why the market is behaving which is why they choose to trade in the same direction or against it. If every trader had the same opinion there would not be sellers and buyers but instead only buyers when the market goes up, or only sellers when the market goes down.
Let’s think of the market as the Facebook platform that everyone is expressing their own feelings in our news feed! In other words, the market represents how you, Warren Buffet, and John from the barbershop feel about it.
Furthermore, sentiment analysis is used by multiple companies if not all to determine overall opinion on a specific topic. Companies use it to create brand awareness and reputation on social media and other platforms by expressing opinions on several matters.
During the covid-19 outbreak, the market experienced its worse ever drop! People were going insane and they could only think of selling their stocks because no one knew when the economy was going to recover. Imagine that if the S&P 500 continue dropping for another 6 days, the index would have reached zero! My point is, traders could only feel bearish and panic with no light at the end of the tunnel.
Fun fact: What traders didn’t know is that they should buy more stocks since everything dropped to ridiculous prices and are now recovering and jumping back up! But who would have known that? You should have been very brave to make a move like that!
Well done, you learned the last of the three main types of analysis. Later on, we will learn about Candlesticks!