How to Measure Market Sentiment? | Stockstoearn


Remember that these market participants often make incorrect market decisions, especially at market extremes. Therefore, the sentiment of the uninformed players is used in a contrarian strategy. Now, we center our attention on the sentiment of informed players — those most likely to make correct market decisions.

Insider Trading


The ultimate informed player, at least in individual stocks or commodities, is the insider. An insider is anyone who is a knowledgeable member of a firm that either trades in the commodity underlying the future most important to the firm’s business, such as oil to an oil company or cocoa to a candy company, or who has knowledge of a company’s internal business prospects and results and is a stockholder. Naturally, these people will act for their own benefit, hopefully within the law, and buy and sell based on their knowledge. Under SEC regulations, corporate insiders must report any stock transactions they make within a month, and in turn the SEC reports these transactions weekly. Because insiders are not allowed to profit from transactions in their company’s stock for six months, their actions are a long-term indicator of prospects for the company beyond six months. Investors Intelligence and Vickers Stock Research have found that the compilation of all insider transactions is useful for forecasting the stock market a year out from the reports.

Sell/Buy Ratio

The Sell/Buy ratio takes into account the total number of insider buy and sell transactions for each company, the percentage of change in insider holdings, the unanimity of the transactions within each company, reversals in transaction patterns, and very large transactions.

Vickers considers a ratio under 2.25 a portent of a higher stock market, and a ratio greater than 2.25 as a sign of impending market problems. Colby (2003) found that between 1971 and 2000, the ratio averaged over five weeks produced for longs only when the smoothed ratio declined below 2.25, a 29.2% profit over buy-and-hold. Bjorgen and Leuthold (2002), using only large insider block transactions, found that from 1983 to 1999, only a small percentage of the time do insiders transact their shares in a one-sided direction, but the three times that they showed excessive buying, the stock market bottomed within several weeks. On the sell side, when excessive selling occurred, the market peaked, and it either declined or consolidated approximately a year later, thus confirming the observations of Investors Intelligence outlined next.

Large Blocks

Large blocks tend to be transacted on behalf of professionals. There are several ways that large block data is used. The first is the use of the total number of large block volume relative to the total volume traded. This figure gives an indication of when the large block trader is transacting the most number of shares relative to the market as a whole. Colby (2003) found that when the large block ratio crossed above its 104-week exponential moving average, a buy signal was generated that was profitable 70% of the time with a net profit of 511% over the period from 1983 to 2001. This strategy was only successful on the long side. The short side, which was triggered by the ratio declining below its 104-week average, ended with a loss.

The anxiousness with which stocks are traded is shown by whether buyers trade on upticks or downticks. Aggressive buyers anxious to get a position in a stock will buy large blocks on upticks. The ratio of blocks traded on upticks to those on downticks is, therefore, an indicator of this professional interest in owning stocks.