What is Market Sentiment - How to Analyse It?

06 June 2024
4 min read
What is Market Sentiment - How to Analyse It?
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Those in the stock market often hear the term ‘market sentiment’. It is an important indicator that needs to be kept in perspective while trading and investing in the stock market.

It can significantly impact a company's fortunes and even shift the direction of the entire stock index/market.

This blog will help you discover more about market sentiment and get insights into how you can use it to your advantage in building up a profitable portfolio.

What is Market Sentiment

Market sentiment reflects how investors feel about a stock, a sector, or the whole market. Essentially, it is the overall attitude and mood of investors.

External factors, such as policy shifts, management actions, natural calamities, or the broader economic condition, contribute to this sentiment. Market sentiments can influence stock prices, both positively and negatively.

Different Types of Market Sentiment

Market sentiment often gets overlooked due to the use of various technical tools and price patterns, but neglecting them can prove costly. Every type of sentiment matters for traders and investors.

So, now that you know market sentiment meaning, let's check the various types of market sentiments-

  • Positive Market Sentiment

When participants feel optimistic about the economy and the market, it leads to positive market sentiment. This encourages greater investment, which in turn drives up prices, which could potentially spark a bull run. 

  • Neutral Market Sentiment

Between optimism and pessimism lies neutral market sentiment. It occurs when investors are not sure about the direction of the market, like whether the price of the stock will rise or fall. During such situations, the market might go through periods of consolidation or stay within a certain price range.

  • Negative Market Sentiment

This occurs during economic uncertainties when investors expect the price of stocks to fall, leading to a negative market mood. In such a scenario, people focus on selling off their stocks. This results in sharp price declines, lowering the demand.

How to Analyse Market Sentiment

The following are the different ways in which you can analyse market sentiment:

  • Financial Reports Analysis

When companies release earnings or when analysts share their views, it can influence how people feel about a stock. Analysing reports like earnings announcements or annual reports can help experts understand how the market might react in the future.

  • Social Media Sentiment Analysis

Social media offers a platform for people to share their views and opinions.

When several posts focus on a particular company's stock, it can influence the stock's market price, either increasing or decreasing it. Typically, if investors feel optimistic about a stock, its price rises, and if they feel negative, the price falls.

  • Market Sentiment Indicators

Many traders rely on various indicators to understand market sentiment. These indicators help identify undervalued stocks for trading. By using these indicators, you can get a sense of where the market is heading.

Real-Life Example of Market Sentiment

Elon Musk bought Twitter for $44 billion in October 2022 and after that, he fired about 3,700 employees, which is half of Twitter’s workforce. This move caused a lot of criticism from the media, the business world, and investors. As a result, Musk's Tesla shares dropped significantly, by 54%.

Tesla's business model was not faulty, but investors reacted strongly to Musk's actions. However, by November 2022, the share prices began to stabilise. This shows how market sentiment can greatly impact stock prices and also how they can change over time.

Different Market Sentiment Indicators

Here are some market sentiment indicators that provide insights into how investors feel about the market and its potential direction.

  • Bullish Percent Index (BPI)

The BPI indicates the percentage of stocks exhibiting bullish patterns within a specific index. If over 80% of the patterns are bullish, it is a bull market, and if 20% or fewer are bullish, it is a bear market.

  • Moving Averages 

A moving average looks at how the price of a particular stock or stock index has been changing over a set period. It looks at the average price over 50 or 200 days. If the 50-day average is higher than the 200-day, it is bearish, and vice versa.

  • VIX (Volatility Index)

VIX is a sentiment indicator that predicts market volatility for the next month. A higher VIX signifies more expected volatility. It is calculated from option prices and implied volatility.

  • High-Low Index

This index counts how many stocks are hitting 52-week highs or lows. If 30 or more are at lows, it is bearish. If 70 or more are at highs, it is bullish.

  • Put-Call Ratio 

It tracks the amount of put options traded compared to call options. When the ratio is high, it usually means people are feeling bearish, while a low ratio suggests bullishness.

  • CoT (Commitment of Traders) Report

Many commodity traders use this report to predict future prices. They often do the opposite of what the majority is doing.

The Bottomline

There are several methods to assess market sentiment and anticipate significant market shifts. While relying solely on sentiment is not sufficient for crafting a trading strategy, it can serve as a valuable supplement to enhance your analysis of market trends.

You may also be interested to know

1.

How Stock Market Affects Economy

2.

How Do Currency Exchange Rates Affect Investments?

3.

How Do Rupee Appreciation And Depreciation Impact the Stock Market?

4.

Bull vs Bear Market: What are the Differences?

5.

How Does the Stock Market Work?
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