Market Sentiment Theory - Market Sentiment Definition
The market sentiment theory, simply put, contends that when the majority of investors are bullish, a top is reached. (If most are really bullish, they've already bought their stock - who's left to buy from them?) Conversely, if the majority is bearish, that's the bottom, because most investors have already done their selling. It's a contrarian view of the market - when most people are bullish, the averages should go down; when most are bearish, they should rise. And it's a theory that, I maintain, is equally valid for the short-term (days) and quick-term (hours) as it is for the long-term (years) and intermediate-term (months).
If we can accurately measure the percentage bullish versus bearish at any given
time our odds of forcasting future price movement increase.
How can we find out how many bears and how many bulls are around at any given time? Logically, heavy call activity is associated with being bullish, and heavy put activity is associated with being bearish. This intuitive knowledge is confirmed by the records of numerous longer-term indicators developed by brokerage firms and investment advisors.
For shorter time periods, I have devised tools that can accurately measure the current market sentiment. My charts of option activity updated every 1/2 hour have done an excellent job of measuring sentiment since 1995. (For a detailed explanation of their construction read the Barron's article)
To learn how my charts measure this put versus call activity go to the tutorial.
