Investment Markets Info.

Investor sentiment needs more pessimism

As investors become more pessimistic, selling in the stock market intensifies. But despite a dramatic four week plunge in the stock market, investor sentiment needs to be even more pessimistic.

Investor's Intelligence Survey; not that intelligent!

The Investor's Intelligence Survey is a measure of investment newsletters. The simple survey asks if their position is bullish (optimistic) or bearish (pessimistic). Recently, the number of bulls has been declining but the number of bears has risen only slightly. In significant corrections and bear markets it is not uncommon for the number of bears to exceed bulls.

At the current time, this measure isn't even close to an extreme. In fact, the stubborn position of investors to not become more bearish is noteworthy. What will it take to rattle investors?





The options market and how it gets it wrong.

As investors become more pessimistic they tend to buy puts in the options market. Holding puts is a strategy designed to profit from falling prices. Accordingly, the number of call options purchased diminishes due to market weakness.

As the decline in the underlying market intensifies, there has been a point historically when the number of equity puts purchased exceeds calls purchased.

You can see from the chart below that the number of puts bought nearly exceeded the number of calls (at .91 on Oct. 13, 2014). But in the last ten years, this measure has spiked to 1.20 when fear escalated. At less than 1.0, it's not quite close enough to declare fear became dominant.  

What to do when investor pessimism is extreme.

When investors are "on the same side of the fence" with their viewpoint, they have carried through with either buying or selling. When investors are in agreement, the market is at a turning point. Intuitively, this makes sense if you work through it. When investors are collectively pessimistic, or bearish, they have taken action by selling their stocks. If the selling is essentially complete, then the market has only one way to go and that is up.

Our research tracks numerous investor sentiment measures as part of an ongoing study of investor behaviours. We study the link between investor psychology to market tops and bottoms. It's part of market timing and picking the biggest winners in the stock market.

Are stocks at lows?

After a significant slide in the stock market, stocks appear to be working on a rally. But there is atleast one problem with thinking stocks have bottomed out. It's too obvious!

It's a relatively easy to conclude stocks are bouncing from their lows. You can see an example below with Bio-Fuel Energy (BIOF). It's just one stock but it's one of many that have suffered big declines and are now into at least the second to third day of gains.

Big Gain Nice, Big Loss Before It Bigger

Stocks can rally a long way in a bounce. Historically it can be as much as 50-60% of the loss preceding the bounce. But an existing characteristic in the markets (stocks, commodities and currencies), is bounces in weaker markets and securities are anemic. In terms of the reality of executing a buy, is it realistic to pull off a profitable trade by the time the sell is made? The evidence to date is not promising.

Power Persists

There's one thing that can be said about the stock market; power persists! The more powerful a gain or loss is, the more likely it will continue following a break. Given the historically large declines over the past month, the first bounce is likely to met with more selling and a return to the lows.

Our research tracks all stocks, categorizing them into conditions based on relative performance and historically valid predictors. Think of it like a sports league, with the best teams at the top, some in the middle and the rest at the bottom.

Going forward, stocks are ranked for the highest success and highlighed with precise timing for buys.


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Commentary including ideas, historical and other market indications are not investment advice. Statistics and other data may be from other sources and may be inaccurate or incomplete. See Full Disclaimer.

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