You may have read that it is important to leave emotions out of your investment decisions. Over the years, various studies have attempted to measure the deleterious effects of letting emotions play too great a role in financial decision making.
However, there is an advantage to be gained by trying to interpret the emotions of investors in general. Specifically, the ability to detect bullish or bearish investor sentiment can be useful when making decisions about your portfolio.
Technical analysis, the evaluation of securities based on historical prices and other trading variables, is based in part on market psychology and thus looks at a host of sentiment indicators for clues about the near future. Here are some examples of tools used to assess investor sentiment.
Rate of mutual fund share purchases and redemptions: The rate at which investors buy and sell mutual fund shares can indicate whether they are concerned about volatility. If more shares are bought than sold, investors are signalling confidence by putting money into the market, and the indication is bullish. If redemptions outpace purchases, investors are pulling money out of the market, possibly in search of a safe harbor, and the indication is bearish.
Initial public offerings (IPOs) during the past year as a percentage of all stocks on the NYSE: The IPO market is highly sensitive to market movements. In general, IPOs tend to come to market when their handlers are confident in a warm reception. A company that wants to go public typically will wait for favorable conditions rather than risk a low debut price. Thus, a low percentage of IPOs may indicate bearish sentiment.
The Advisors’ Sentiment Report: Since 1963, Investors Intelligence, a market research firm, has surveyed independent market newsletters to determine whether the authors are bullish, bearish, or forecasting a correction. In general, the report takes note when opinions are arrayed outside the normal pattern, which is considered to be 45% bulls, 35% bears, and 20% neutral. If a large percentage becomes bullish or bearish, it can indicate that a market reversal may be in the offing.
Although investor sentiment can be a useful indicator, it takes a skilled eye to interpret its meaning and determine whether to respond. A professional perspective can help you consider investor sentiment in relation to historical data, current conditions, and a range of other variables.
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