Does Market Sentiment Really Tell You Anything?

03/26/2014 9:03 am EST

Focus: STRATEGIES

J.C. Parets

Founder, All Star Charts

Technician J.C. Parets explains how he uses sentiment indicators in combination with technical tools to identify opportunities and trade them.

SPEAKER:  I'm here with J.C. Parets, and we're talking about market sentiment.  As a technician, what role does market sentiment play in your analysis, and how would you even read it? 

J.C.:  I think it plays a big role.  As a technician, we have many tools at our disposal.  Obviously, price is the only thing that pays, and everything other than that is supplementary, whether it be volume, or whether it be momentum or seasonality, sentiment is another one of those.  We look at sentiment a lot of different ways.  There are the polls that we all know about:  The AAII poll, which asks retail investors whether they're bullish, bearish, or neutral over the next six months.  There's the National Association of Active Investment Managers, NAAIM.  It's another good survey.  We're looking at Investors' Intelligence, Barron's Consensus Inc. every Saturday.  All different asset classes.  I think that that's very important.  What I try to see is the extremes.  Obviously, in sentiment, there's a lot of noise.  There's this percentage bulls, there's this percentage bears, and it's usually very noisy in the middle; it's when it reaches the extremes, 10% bulls or 8% bears.  When it reaches those extremes, the unwind of that extreme sentiment creates very, very powerful trading opportunities. 

SPEAKER:  That brings to mind the Greek crisis a few years ago.  Everybody was worried that Greece was going to fall into the ocean, the world was coming to an end, the financial markets were going to explode, and there was a huge premium placed on that.  It turned out not to be such a big deal.  How did you read that situation? 

J.C.:  I was actually very vocal about it at the time.  This is summer 2012.  European stocks are selling off hard, led by Greece, of course; the euro versus the dollar selling off as well.  There was a very high correlation between those two at the time, and the sentiment, to your point, was extremely bearish.  They were calling the euro an experimental currency.  It was being dubbed that at the time.  That's the truth.  Everyone just assumed that Greece was getting out of the euro zone, and Germany's bailing everybody out.  It was a complete disaster, and I was writing about how this is potentially setting up to be my favorite trade, and I was writing about it every single day and kind of following up, and sure enough, and that's where bringing all our technical tools together so we have this extreme bear sentiment.  Now, as prices are making new lows in European stocks, prices of the euro versus the dollar making new lows, Greece making new lows.  Momentum was putting in higher lows at the time, and that's the beauty of technical analysis is bringing in the other tools that we incorporate.  Sentiment, obviously, was the one that triggered us to pay attention to it in the first place. 

SPEAKER:  Right. 

J.C.:  .that extreme bearishness. 

SPEAKER:  So you're not just talking about divergence, momentum versus price, but we're also talking about divergence, public sentiment versus probable reality. 

J.C.:  That's right.  When everyone is expecting a crash to occur, chances are it's probably not. 

SPEAKER:  Thanks, J.C.  That's great information.  You're watching the Money Show video network. 

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