Excellent point. Here's an article(to your point) I picked up today on the plane. Everyone, including Dep, should read this considering the action with OUR aol this week:
Gauging The Market: How Does it Feel?
Psychological Indicators Provide Strong Clues On Direction
THE NEW INVESTOR: Getting Off On The Right Foot
By Leo Fasciocco
Investor's Business Daily – April 16,1999
Many investors who think about buying a stock first ask a friend's opinion.
It's human nature. We get comfort in knowing the stock we want to buy sounds good to someone else.
Perhaps you take the same approach to the general stock market. You're fully invested in stocks, and all you hear is that the market looks great and should go higher. You feel good.
Well, you shouldn't. Instead, you should be cautious and alert. Why?
There is a cardinal rule drawn from years of experience by top market analysts that when everyone is invested and everything looks great, the market and individual issues could be near their peaks.
The reason: All the good news is out. Everyone who was going to buy has already done so. So the next move often is down as sellers in the market start to outnumber buyers and send prices lower.
How can we know for sure just when most of the buying or selling is truly
done?
Psychological indicators, found in IBD on the General Markets & Sectors page (see page A20), give strong clues.
Over the years, analysts have come up with some very ingenious ways to measure in quantitative terms when investor sentiment reaches important extremes, which often mark the turning point in market direction. These can be a big help to you when making buy and sell decisions.
For example, in October the Dow Jones industrial average was in a down trend. It touched 7469 on Oct. 9. Things looked dreadful. The Dow was off 1,898 points, or 20%, from its peak. The NASDAQ showed an even greater loss.
However, a look at the IBD chart of Ratio of Trading Volume in Puts Versus Calls (see the NASDAQ Composite section at the top of A20), showed a big jump to 1.1%.. Historically, that was an extreme in bearish feeling among options players. It said options players were rushing to buy puts, expecting a further market decline. Puts give the buyers the right to sell stocks at a specified price by a certain date. Option players were almost in a panic worrying about a drop.
'Wrong-Way Crowd'
Research has shown that options buyers are usually wrong on the direction of the stock market. They are the "wrong-way crowd." So the extreme bearishness of options players in October was a clue the market might be ready to turn up.
It did a week later.
The Dow surged 330 points on Oct. 15 to 8299. It was a signal to enter the stock market. The Dow proceeded to soar to 10,000 by March. Many stocks did sensational the next six months. America Online quadrupled and Dell Computer doubled.
Three important points to remember when looking at sentiment indicators are:
 They work best at extremes.
 They are secondary indicators.
 They can be contrary indicators.
For example, the put-to-call volume indicator works best at extremes. Most of the time it just floats in a range, not saying anything.
It was not the primary indicator of the stock market turn. The market itself (the Dow industrial average, the NASDAQ composite and the S&P 500) was, but the sentiment indicator was an alert a change in direction might be coming.
It was a contrary indicator in that one would trade in the opposite direction of the options players who were being tracked. They were bearish. So you would be bullish.
Another wrong-way crowd one would go against is investment advisers surveyed by Investors Intelligence. IBD shows weekly data on the advisers and displays them with a graph (also on Page A20).
History shows when 55% or more of advisers get bullish, the market may be near a top. That fits with the idea that when the majority are bullish it means everyone is probably in the market. Conversely, when the ratio of bullish advisers drops below 35%, then the market could be close to a bottom.
When the stock market topped out before the big October 1987 crash, bullish advisers soared to 85% earlier in the year. Again, the sentiment indicator did not give a precise top, but a warning.
Are there any "right-way crowds?"
Yes. New York Stock Exchange specialists are generally right. They are the ones who help make a market and facilitate trades. Studies show they tend to be right on market direction. The indicator IBD uses to show their trades is the ratio of shorting by the public to shorting by NYSE specialists.
The public-to-specialist ratio was the highest in the past year on Sept. II, 1998. That's when the Dow was scratching a low around 7790. The ratio showed the public was doing a lot of shorting (playing stocks to go even lower), while the "smart guys" were not.
It turned out to be a buying opportunity as the Dow climbed steadily afterwards.
You may want to list the psychological indicators you want to watch each day and mark each one either bullish, bearish or neutral.
When many sentiment indicators line up in one way, either bullish or bearish, keep close tabs of the general market averages such as the Dow Jones industrial and NASDAQ composite. If they start to change direction, it is a good signal for you to take action. |
