Here’s the thing about market sentiment: It’s hard to gauge.
But we don’t have to pretend.
We know.
It’s quite obvious, however, that other people, with extreme insecurities, do actually have to pretend.
And they’re embarrassing themselves.
Technical Analysis, broadly defined, is the study of the behavior of the market.
Sentiment, in the context of Technical Analysis, is the specific study of the humans who participate in and determine market behavior.
When we study sentiment, we’re looking at human beings and their mindset as opposed to price action.
Understanding the psychological and emotional state of any one human is hard enough.
Getting a grip on an entire global financial market’s worth of human beings is even harder.
And, given that we humans make them, all sentiment indicators are flawed.
Some are way more flawed than others, though.
Newer indicators – from random sources never even formally trained in Technical Analysis – are getting progressively worse.
And it’s not going to stop.
Expect more bad sentiment indicators from less informed investors.
And that’s good.
I have no problem with investors who don’t know any better being misled by content creators – classic blind-leading-the-blind scenario.
Ultimately, what they’re creating is more opportunity for you and me to profit.
CNN Fear & Greed Index
The classic case of the useless sentiment indicator is of course the CNN Fear and Greed Index.
This is the template for the charlatans introducing their own worthless gauges:
The problem is in its construction.
There’s barely any data in the “indicator” that even involves sentiment.
CNN uses seven data points for this reading. The first three are trending in nature, not mean-reverting: momentum, price trends, and market breadth.
To use these data points as a contrarian measure of fear and greed is already flawed.
Garbage in, garbage out.
Another two have to do with the Bond Market.
You see, the people who made up this indicator did so during a deflationary regime when stocks and bonds had a tendency to trade inversely amid elevated stress.
But, historically, that isn’t always the case.
And it certainly hasn’t been the case for several years now.
Indicators that only make sense in certain regimes are doomed to fail.
This CNN thing fits the bill.
Two measures of market behavior they use that are, in fact, mean-reverting, particularly from extremes, are the Cboe Volatility Index and put/call ratios.
These two are actually not terrible additions to this indicator. The rest make little sense.
To CNN’s credit, they provide a lot of detail and show us how their indicator is constructed.
So we can decide for ourselves whether it deserves our attention or not.
Some of these newer “indicators” don’t even show you how they’re calculated.
Those are the worst ones.
Don’t just walk away when you see that.
Run.
Right vs Wrong
CNN is pretty above-board.
But the conflicts of interest when it comes to others creating similar indicators are even worse than you think.
Some of them are built by people who don’t know any better. But they employ people who do know better.
And these people can’t even stand up and acknowledge the uselessness because they can’t get a job anywhere else.
So they just keep their mouth shut hoping it all goes away.
But their bosses want them to push that garbage on ignorant people who have no way of knowing how bad it actually is.
This is a classic case of hurting your audience for your own selfish gain.
We see it all the time.
They’re all wrong.
And we love that.
We’ll keep showing you what’s right.
I can’t help myself.
Stay sharp,
JC Parets
Founder, TrendLabs