Trying to interpret market sentiment indicators is tedious. How people are feeling about the markets, their finances and job situation, inflation and other economic components is difficult to measure. Our feelings about these things are dynamic, changing from week to week or even day to day. How often have you felt positive about the economy one week and completely negative the next week?
Tedious as it might be, it’s important to understand market sentiment, as it can help us make money and save us from losing it.
Here’s how to use market sentiment indicators
Fear/Greed Index
Every human is on the fear/greed spectrum. We fear losing money and are greedy about making money. The Fear/Greed Index measures where the majority of us fall on that spectrum at any given time.
When markets are going down, most investors/traders become fearful and express that fear with action. What is that action?
They hit the sell button, of course!
“Who wants to stick around for lower prices,” they think. “I’ll just sell and wait for a new entry point.” This is one of the four fears of trading: fear of loss.
Meanwhile, when the stock market is going up we want to be on board at all costs, even if it seems too late. This is the classic fear of missing out.
Where people are sitting on the fear/green index is a strong indicator of market sentiment.
Volatility Index
The volatility index, or VIX, is my favorite gauge of market sentiment. When the VIX rises, fear is on the rise. Most people are selling or considering it.
As a contrarian trader, I use this as a signal to take a position, because this indicator (like so many sentiment indicators) tells me when the crowd is leaning too heavily in one direction. If everyone is on one side of the boat, it’ll tip over.
When the VIX is dropping, it means people are feeling complacent. They are buying – or at least, they are not selling.
There are several other sentiment tools that I use in my trading to understand how people are feeling, but I always keep an eye on the VIX and often talk about where it stands on my Daily Bites. So join me before the bell live on Twitter Mondays and Thursdays, or get my update in your inbox.
