The International
Securities Exchange launched the ISE Sentiment Index (ISEE) in 2002. This
index is to gauge retail investors’ sentiment in the market by measuring the
number of opening call options vs. opening put options, which are placed orders
on the International Stock Exchange platform.
ISEE=Opening Calls /Opening Puts x 100
When the ISEE reaches around 100 which is trend
line, the sentiment is treated as neutral status. When the ISEE is above 100, for example 150,
it means for every 100 units of put option orders are there are placed, and 150
units of call option orders are placed during the same time frame. This case shows that investors are optimistic
about the market. The higher the ISEE
reading, the more bullish the market sentiment is deemed to be. Conversely,
measures below 100 signal pessimistic views from the retail investors.
The leading publications often referred ISEE as a
helpful trading means due to its inventive arithmetic technique. It enables investors and traders, even
investment professionals, to examine with this exclusive call/put ratio, how
retail investors view the general stock market.
Therefore investors can make trading decisions based on the sentiment
derived from ISEE.
Some studies show that a gathering of consecutive
highs or lows in ISEE reading indicates that the market might move in the
opposite direction of what the retail investors are betting on. This
characteristic identifies the ISEE as a contrarian indicator.
As a contrary indicator, we are looking for rising
prices when ISEE reading is low-hanging, and retail investors show pessimism
about the stocks or market. Conversely,
when the ISEE index poises at a high level, the market prices are going to
drop.
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 ISEE values have been quite bullish or
bearish omens.
Most often, when everyone is very bullish and wants
to buy stocks, most investors have already been in the stock market. The buyers exhaust or extinguish their
purchasing power. The demand has been
met and it becomes remarkably difficult for stock prices to continue to gain as
investors expect. This case may spark a
sudden sell-off. Meanwhile, the stop-loss orders might trigger and accelerate
the downward process.
The opposite situation might present after dismay
sell-off. If everyone jumps out of the
window and disposes shares about the same time period, then the market becomes
gradually stable. The market or stock
price starts to advance when the bargain hunters purchase shares. The surge in
price is going to prompt a short-covering rally. Moreover, regretful investors
buy back shares which they disposed, and fuel the rally even more vigorously! As a matter of fact, when bountiful investors
stretch out to bet on the downside of the market, eventually the stock price
might be close to oversold and poised for a nice rebound.
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!
Credited to http://www.ise.com/market-data/isee-index/
http://stockcharts.com/school/doku.php?id=chart_school:technical_indicators:relative_strength_index_rsi
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