Sentiment is defined as a view or an opinion. It can also mean an altitude, emotion or a strong feeling. In the financial markets, investor sentiment expresses the general mood among investors about a financial market or a financial security. By studying market sentiments one can gauge the historical extreme levels associated with excessive optimism or pessimism in the marketplace.
The stock market have been associated with major events that reflect excessive investor sentiments and hence extreme investor behavior including the Great Crash of 1929, the Nifty-Fifty bubble of the early-1970s, Black Monday crash of Oct 1987 and recently, the Tech/Telecom Bubble of 2000-2002 and the Global Financial crisis of 2007-2009. Those that study behavioral finance, believe investors are subject to sentiment and periods of extreme investor sentiment can push financial markets to extraordinary levels, both to the upside as well as to the downside.
So, the question is not if investor sentiment impacts stock prices, but rather how to better quantify investor sentiment and which specific investor sentiment indicators are most useful for traders and investors, alike. There are quite a few sentiment indicators available today. However, there are three investor surveys that tend to offer specific insights into the mindsets of the different type of investors in the marketplace. They are as follows:
AAII Investor Sentiment Survey – This weekly survey measures the percentage of individual retail investors who are bullish, bearish, and neutral on the stock market in the next 6 months. Since 1987, the average level for bullish investors is 38.0%, for the bearish camp the average is 30.5%, and for the neutral investors it is 31.5%. AAII survey is widely followed on Main Street and on Wall Street. The weekly survey gives reliable insights into the mood of individual investor over the near-to-medium term and is often deployed as a classic contrarian indicator.
Wall Street Sentiment Survey – Each week, a survey is conducted on a group of diverse and distinct traders and analysts. Like the AAII survey, extreme readings are often interpreted as a contrary indicator. However, it is noted that because those that surveyed are professional investors and analysts, the weekly readings may not be truly contrary, at least from a short-term trading perspective. When there are even splits among the group it tends to be a reliable early warning signal for an impending turn in the marketplace.
Investors Intelligence Bull/Bear Survey – This is another weekly sentiment survey that records the opinions of the 100-plus investor advisory services that are currently available for investors. Some believe the sentiment readings from the advisory group are better informed or more knowledgeable, and as such it tends to be quite early. Since this group are widely followed by professional investors such as hedge funds, money managers, and large institutional investors persistent and excessive readings are more valuable than one or two excessive reading as they are conveying real, excessive market conditions. So, at extreme and persistent market conditions the readings from this indicator are not considered to be contrarian.
Enclosed below are the recent investor sentiment surveys. In general, it appears that these sentiment surveys and others are not yet trading at extreme levels that is associated with major market tops in the past. Rather, the current interpretation is that the market rally still has legs before it finally reaches a heightened and unsustainable level.