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Sentiment
Indicators I Could Not Live Without

By Gary
Kaltbaum

TradingMarkets.com

 

This is a
follow-up to an

earlier piece about some of the sentiment indicators that I
watch. These are contrarian indicators, meaning if they flash too much
bearishness, it may be time to go the other way. Now it is imperative to
remember that regardless of these indicators, for me, market action will
always take center stage. Sentiment is secondary to my work but has to be
watched especially when the numbers hit extremes. I will start getting real
excited with powerful stock market action.

What have some of these indicators flashed recently?

Front Cover Indicator: Back at the ’98
lows, Newsweek, Time, Fortune, Forbes and even
Esquire had front covers depicting crashes and bears. Of course, this
happened after the drop. These magazines are notorious in reporting the news
loudly after the move has already been made. Pictures of bears and declining
charts in Newsweek, Time, U.S. News, and The
Economist get me wondering: Could they have called the low for the cycle
again? Hmm…

 

Put/Call Ratio: During good times, people are optimistic. In
such times, more often than not, investors are buying calls…betting on
higher prices. But what happens when investors are panicky? They buy puts.
When the ratio of trading volume in puts vs. calls hits above 1.0, it is
considered extreme pessimism and can possibly signal a turn in the market in
the near-term. Put/Call Ratios can spike to
extreme numbers on really bad days as investors bet on lower prices
after the drop. Hmm…another notch in the
bull’s belt.

VIX/VXN: You may have seen my
occassional references to certain volatility measurements. These two numbers
can also go to extremes during panic days. In layman’s terms, they measure
the tone of the selling, which, to say the least, can get panicky at the
lows. The VIX on such occasions can move above 40,a number believed to be
extreme. When the VXN moves above 80, I would say the VXN as a contrary
indicator has turned green.

ARMS Index: Many people call this the
“perfect indicator” because it so rarely signals, and only with extremes. An
extreme number of 1.5 has only been hit on several occasions. The last few
— Sept. 3, 1981; Aug. 2, 1982; Oct. 16, 1987; Nov. 30, 1987; Oct. 27, 1987;
and (drum roll, please) March 16, 2001. I use this as another measurement of
panic and volatility in looking for the lows.

The things you hear every day: Yes, this
is one of my favorites. Back at the lows in 98,I was listening to rumors of
Banker’s Trust and Lehman Brothers filing bankruptcy. I was listening to the
supposed destruction of the finance system because of a hedge fund. Russia
and Mexico imploding. Get the hint. Think about what kind of talk you have
heard at tops. Conversely, what have you heard at lows? Depression,
recession, the next Japan, layoffs, bankruptcies, analyst downgrades,
lowered estimates, no visibility, stagflation. I don’t remember ever hearing
this type of talk at the highs, only the lows.

All in all, just some more ammunition for your investing. When sentiment
numbers go to extremes, it is like an alarm bell for me.

 

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