History has shown that
when the herd moves in one direction, it may be time to consider going the
other way. Therefore, the sentiment detection in the stock market becomes
increasingly crucial in our financial life.
We are not saying the
retail investors are always wrong about the market. However, the majority of
“dumb money” retail investors who are known as “the herd” are often times
mistaken about the major turning points.
This phenomenon is
related to herd mentality and herd behavior.
More and more experts and economists study Behavioral Finance to
identify and predict the rational and irrational behavior of investors. One way
or the other, we can identify this phenomenon by observing when sentiment
extremes occur among retail investors. Historically, extremely high or low ISE
Sentiment Index (ISEE) values have been quite bullish or bearish omens.
The logic behind the
ISEE index is that inordinate orders placed for either calls or puts underlines
the ultimate levels of optimistic or pessimistic judgment. Generally speaking, the overwhelming
bullishness usually foretells an overcrowded market condition. The market becomes vulnerable (weak) and even
dangerous!
The
stock market reached an all-time high on 10/9/2007. From 8/29/2007 through
10/9/2007, the ISEE readings were between 87 and 187, only two of these
readings were under 100. We noticed this time period had the largest clusters
of high ISEE readings in history. We are sure everyone knows the story that
followed that day 10/9/2007. It
demonstrated that in the year 2007, ISEE were at clusters
of consecutive highs. It appeared to effectively indicate the market was at a
turning point.
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.
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reading. Come back more often, more updates are coming.
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