The stock market's latest pullback has some bulls on edge.
After an uninterrupted rally that started in November, the
recent pullback deleted 5% of gains and has thus far become the
largest correction since then.
My article "
Are Technicals Signaling a Storm Ahead
" already suggest a heightened sense of insecurity, and now I'm
watching a few key things concerning market sentiment (or mood of
the market) to keep us ahead of a deeper correction.
How to Use Sentiment Data
If I told you that a certain penny stock trading on the Nasdaq
(NYSEARCA:QQQ) hit record highs in May 2013, you likely would
dismiss it and say so what? I most certainly would, mainly
because we have no clue if the stand alone data is meaningful
information or not.
But if I told you that the amount of aggregate tradng in penny
stocks just surpassed the previous peak levels that occurred in Feb
2000 (coinciding with the Nasdaq's all time price high), we start
to get a better idea of how the data can be helpful.
By itself it may not be meaningful, but when compared to the same
data throughout history, it can be eye-opening, especially in
recognizing extremities. This is how a lot of sentiment
analysis works. The Nasdaq penny stock action is really put
in perspective when it is revealed that typically penny stock
volume peaks at market peaks and bottoms at market bottoms.
The below table and simple chart of the Nasdaq (NYSEARCA:QID)
captures the penny stock volume at recent major market peaks and
troughs (in red). A pickup in penny stock action on the
Nasdaq (NYSEARCA:PSQ) may be warning of a topping market as
speculators again go to extremes chasing penny stocks and a rising
The Bigger Picture
This is just one sentiment example and may just be coincidental and
not proving anything, which is why in the
ETF Profit Strategy Newsletter
I looked at over 25 other sentiment indicators to get a better idea
of current levels compared to historical market peaks and troughs.
An example of that report is shown below with a key takeaway that
almost all sentiment indicators have reached or were again very
near their all time high bullish levels recently. This data
overwhelmingly shows that the market (NYSEARCA:VTI) was likely much
closer to a major long term selling opportunity than a major buying
Three of the many popular adviser surveys are shown below as they
were included in the Newsletter analysis. Two of the three
recently reached their all time high bullish levels and the third
was in the upper levels of its historical past. By comparing
the levels associated with market tops to levels associated with
the 08-09 low it is clear that there is a distinguishable
difference between bullishness during market tops and bearishness
during market bottoms.
Advisors in these surveys become most bullish near market tops and
most bearish near market bottoms, exactly opposite of what they
We summarized our findings by saying,
"Sentiment can be a very powerful driver of share prices
(NYSEARCA:IWM) as the herding mentality of investors can takeover
near market tops and bottoms. Being able to recognize such
times in history can help you stay clear of irrational investment
Abenomics and Sentiment
Japan's recent market rise was accompanied by record smashing
bullish sentiment as measured by the Tokyo Stock Exchange's margin
and commitment of traders (
) data. For only the second time in history Japanese margin
traders as a whole actually carried net positive positions
(profitable). Moreover, large speculators were the net
longest they have ever been since at least the early 90's.
Typically these traders are considered the "dumb money" because
over the long run they are usually on the wrong side of the
trade. No doubt, this would not last, and it didn't.
We knew sentiment was ripe for a major reversal in the Japanese
stock market's (NYSEARCA:EWJ) uptrend and that a reversal in the
positions of the long margin traders and speculators would lead to
a deep Japan (NYSEARCA:DXJ) decline, we just needed to wait for
price to confirm the trend change before we could capitalize on the
price and thus sentiment reversal.
On 5/22 that trend reversal occurred and on 5/29 we advised
going short the Japanese market in our
by buying the ProShares UltraShort Japan ETF (NYSEARCA:EWV).
We also recommended put options. EWV was at $21.17 then and
rose above $23 within a week in a great example of how a shift in
sentiment can move the markets very quickly.
What to Expect
With sentiment in the U.S. markets having already reached
peak bullishness it is likely the majority of buyers have now
already bought in. This means the risk is now likely to the
downside. With the recent pullback in price, we may finally
be seeing the technical picture breakdown. Next to follow
would be overall sentiment deterioration that would drive prices
Once two key price levels I am watching are breached to the
downside, it is likely the large amount of bulls will start to
reverse their positions and switch their overall sentiment to a
more neutral or bearish stance, just as the Japanese market is
The ETF Profit Strategy Newsletter focuses on fundamentals,
technicals, sentiment, and common sense to follow the world's
markets. We publish a twice weekly Technical Forecast and
weekly ETF Picks to stay ahead of key trends and turning
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