BASIC TECHNIQUES
Weather Vane For The Market
Bullish Consensus
by David Penn
This enduring sentiment indicator was designed specifically for the futures markets."Paradox is one of the deepest and most important secrets of life, and ... irony is the punishment for not having understood that."
-James Dines, How Investors Can Make Money
Using Mass PsychologyDuring times of confusion in the markets, studies of market sentiment tend to become popular. This is probably unfortunate. It is the absence of a clear, distinct trend that forces uncertain market players to look away from their indicators and trendlines, their oscillators, and their cycles for something -- anything -- that can explain why the markets are acting the way they are. For many traders, a peek at what the smart money is doing is often an irresistible salve against the confusion of a marketplace that seems incapable of making up its mind.
Why "unfortunate"? I say this because during trading ranges, the "smart" money is often no more convinced of its next position than the "dumb" money. As Marc Faber noted in his excellent short essay, "Timing Your Leap Into the Unpopular," "At most major turning points or milestones in financial history, the minds of most investors are as if paralyzed."
This may be no less true of lesser turning points in the markets and the economy. In fact, in some cases, when the smart money does in fact have a strong opinion on the near-term direction of the market, it uses trading ranges as accumulation and distribution areas, taking advantage of the drop in volatility and lack of a long-term trend to reverse a position or to add to a position discreetly. As a trend-follower might say, when the market isn't really going anywhere, neither should you. Consolidations and trading ranges are best not "gamed" -- they are best waited out.
So when is market sentiment truly worth watching? The best time to begin tracking sentiment is when that market appears to be reaching an extreme point, a high or low that seems out of sync with market fundamentals or price action (that is, a new high during a negative divergence in a key indicator).
Because sentiment is most clearly read -- and most passionately felt -- during market extremes, market sentiment is a particularly valuable tool for those market players looking to take contrarian positions vis-à-vis the market. While it is true that market sentiment can also be helpful in keeping a trader on the right side of the market, it is the contrarian character of sentiment analysis that is often the most telling use of this market information.
...Continued in the November 2003 issue of Technical Analysis of STOCKS & COMMODITIES
Excerpted from an article originally published in the November 2003 issue of Technical Analysis of STOCKS & COMMODITIES magazine. All rights reserved. © Copyright 2003, Technical Analysis, Inc.
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