How ISE Sentiment Index Correlates with the S&P 500 from short-term and long-term view

The ISE Sentiment Index is used to gauge the market sentiment by examining bullish bets against bearish bets.

This indicator can be used to detect the short-term trading opportunity. Even if the current ISEE levels are much lower than those prior to the financial meltdown.  Occasionally, the ISEE shot high. 

On 5/21/2013, the Dow Jones Industrial Average closed at a record high 15,388.  The ISEE reading was 142, and touched 186 intraday, a level not seen for quite a while. Next day, the Dow closed down 80 points, and the market had a minor correction until 6/5/2013. The market lost a total value of about 5% during this time period.

On the other hand, The Dow Jones plunged 217 points on 6/5/2013, and ISEE closed at 61, the lowest reading since 5/1/13. The ISEE touched 49 intraday. The next two days, the Dow went up 80 and 207 points, respectively. The market made a reversal since then.  Please be mindful that the ISEE works as a relative number, not an absolute number.  Even if the reading 142 was not high compared with the readings in 2007-08, it reached a high in recent months.

People might think it is just a coincidence that when the ISEE is higher than usual, the market goes down, and vice versa.  

We examined the ISEE extremes occurred between 7/11/2011 and 7/31/2013. Most of these extremes (highs or lows) occurred near the top or bottom of cycles.  Generally speaking, when the market was at a climax, the ISEE was also high. This means retail investors were optimistic about the future movement. However, it ended up with a pullback or correction. When the market was at the bottom, the ISEE was low too, usually less than 100.

The low ISEE readings ranged between 41 and 96, which demonstrated the pessimistic view from the retail investors when the market was at low levels.  These readings are showing the clusters of numbers.  Other numbers around these days revealed the numbers in the neighborhood. 

Please note, if the ISEE reaches the extremes, it usually signals a reversal point in the market or price.  It may not be imminent, but it usually takes place very soon within the next few days. 

          The market usually goes the opposite way of the ISEE reading. We are not saying it works 100% of the time. However, if the reading appears to be out of the box, it is definitely a red flag to watch, especially when you combine this information with other indicators to find out the market is in overbought territory.

          Thanks for your visiting and reading. Happy trading!