“Bull markets are born on pessimism, grow on skepticism, mature on optimism, and die on euphoria.” -Sir John Templeton
In a fair and free market those words hold true, but in the current climate of the worldwide monetary experiment called Quantitative Easing, maybe not so much anymore. Outside of the big picture wisdom of Sir John and his long-term investment horizon, we can use shorter-term indicators of sentiment to give us an edge in our daily market operations. Besides the well-known tedium of running put/calls every day and a moving average on that number for our favorite stocks and indexes, we can utilize a broader gauge of sentiment, provided to us for free by no other than TV cable and internet news outlet CNN Business. One can record and then plot this daily reading at the end of the day, and run moving averages on it as well, which will smooth out some of the volatility and will alert the astute trader on when psychology is changing.
The CNN Business Fear & Greed Index is a compilation of seven different measurements of sentiment. The components are as follows: safe-haven demand, junk bond demand, CBOE put/call ratio, market momentum, stock breadth, market volatility, and stock price strength. And are thus explained.
Safe Haven Demand is a measure of the performance of stocks in relation to bonds over the last 2 years.
Junk Bond Demand is a measure of the interest rate differential between low-quality junk bonds and investment grade corporate bonds.
Put / Calls on the CBOE which measures volumes of puts traded to calls traded.
Market Momentum is measured in relation to the S&P 500 and utilizes a 125-day moving average. It is a relative gage as to how far or below the tendency of the market to trade in relation to that moving average over the last 2 years.
Stock Price Breadth utilizes the McClellan Volume Summation Index, a measure of volume going into advancing issues vs. volume going into declining issues.
Market Volatility is a measure of the CBOE volatility index (implied vol).
Stock Price strength is a measure of the number of stocks hitting 52-week highs vs. the number of stocks hitting 52-week lows.
One should observe the character of the CNN Fear/Greed Index before trading on it. What appears to be an oversold or overbought indication can remain that way for an extended period of time. It is only upon the reversal that the trader should take note. Because of the influence of QE overbought indications in the index have been prevalent and thus should be considered in the context of that. Oversold indications have proven profitable as recently as a month ago. It is up to the trader to determine if this fits within their own investment and trading style. As always, speculation is observation pure and simple. Pattern recognition in sentiment goes into that. Stay wary, stay nimble, stay safe, trade well. Cheers!
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