Market Sentiment
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Market sentiment, also known as investor attention, is the general prevailing attitude of
investor An investor is a person who allocates financial capital with the expectation of a future Return on capital, return (profit) or to gain an advantage (interest). Through this allocated capital most of the time the investor purchases some specie ...
s as to anticipated price development in a market. This attitude is the accumulation of a variety of
fundamental Fundamental may refer to: * Foundation of reality * Fundamental frequency, as in music or phonetics, often referred to as simply a "fundamental" * Fundamentalism, the belief in, and usually the strict adherence to, the simple or "fundamental" idea ...
and
technical Technical may refer to: * Technical (vehicle), an improvised fighting vehicle * Technical analysis, a discipline for forecasting the future direction of prices through the study of past market data * Technical drawing, showing how something is co ...
factors, including price history, economic reports, seasonal factors, and national and world events. If investors expect upward price movement in the stock market, the sentiment is said to be ''bullish''. On the contrary, if the market sentiment is ''bearish'', most investors expect downward price movement. Market participants who maintain a static sentiment, regardless of market conditions, are described as ''permabulls'' and ''permabears'' respectively. Market sentiment is usually considered as a
contrarian A contrarian is a person who holds a contrary position, especially a position against the majority. Investing A contrarian investing style is based on identifying, and speculating against, movements in stock prices that reflect changes in th ...
indicator: what most people expect is a good thing to bet against. Market sentiment is used because it is believed to be a good predictor of market moves, especially when it is more extreme. Very bearish sentiment is usually followed by the market going up more than normal, and vice versa. A ''bull market'' refers to a sustained period of either realized or expected price rises, whereas a ''bear market'' is used to describe when an index or stock has fallen 20% or more from a recent high for a sustained length of time. Market sentiment is monitored with a variety of technical and statistical methods such as the number of advancing versus declining stocks and new highs versus new lows comparisons. A large share of the overall movement of an individual stock has been attributed to market sentiment. The stock market's demonstration of the situation is often described as ''all boats float or sink with the tide'', in the popular
Wall Street Wall Street is an eight-block-long street in the Financial District of Lower Manhattan in New York City. It runs between Broadway in the west to South Street and the East River in the east. The term "Wall Street" has become a metonym for t ...
phrase "''the trend is your friend''". In the last decade, investors are also known to measure market sentiment through the use of news analytics, which include
sentiment analysis Sentiment analysis (also known as opinion mining or emotion AI) is the use of natural language processing, text analysis, computational linguistics, and biometrics to systematically identify, extract, quantify, and study affective states and subjec ...
on textual stories about companies and sectors.


Theory of investor attention

A particular thread of scientific literature connects results from
behavioural finance Behavioral economics studies the effects of psychological, cognitive, emotional, cultural and social factors on the decisions of individuals or institutions, such as how those decisions vary from those implied by classical economic theory ...
, changes of investor attention on financial markets, and fundamental principles of
asset pricing In financial economics, asset pricing refers to a formal treatment and development of two main Price, pricing principles, outlined below, together with the resultant models. There have been many models developed for different situations, but cor ...
: Barberis ''et al.'' (1998), Barberis & Thaler (2003), and Baker & Wurgler (2007). The authors argue that behavioural patterns of retail investors have a significant impact on market returns. ''At least five main approaches to measuring investor attention'' are known today in scientific literature: financial market-based measures, survey-based sentiment indexes, textual sentiment data from specialized on-line resources, Internet search behavior, and non-economic factors.


First approach

According to the first approach, investor attention can be approximated with particular ''financial market-based measures''. According to Gervais ''et al.'' (2001) and Hou ''et al.'' (2009),
trading volume In capital markets, volume, or trading volume, is the amount (total number) of a security (or a given set of securities, or an entire market) that was traded during a given period of time. In the context of a single stock trading on a stock exchang ...
is a good proxy for investor sentiment. High (low) trading volume on a particular stock leads to appreciating (depreciating) of its price. Extreme one-day
returns Return may refer to: In business, economics, and finance * Return on investment (ROI), the financial gain after an expense. * Rate of return, the financial term for the profit or loss derived from an investment * Tax return, a blank document or t ...
are also reported to draw investors’ attention (Barber & Odean (2008)). Noise traders tend to buy (sell) stocks with high (low) returns. Whaley (2001) and Baker & Wurgler (2007) suggest
Chicago Board Options Exchange The Chicago Board Options Exchange (CBOE), located at 433 West Van Buren Street in Chicago, is the largest U.S. options exchange with an annual trading volume of around 1.27 billion at the end of 2014. CBOE offers options on over 2,200 compani ...
(CBOE) Volatility Index (
VIX VIX is the ticker symbol and the popular name for the Chicago Board Options Exchange's CBOE Volatility Index, a popular measure of the stock market's expectation of volatility based on S&P 500 index options. It is calculated and disseminated ...
) as an alternative market sentiment measure. Credit Suisse Fear Barometer (CSFB) is based on prices of zero-premium collars that expire in three months. This index is sometimes used as an alternative to VIX index. The Acertus Market Sentiment Indicator (AMSI) incorporates five variables (in descending order of weight in the indicator): Price/Earnings Ratio (a measure of stock market valuations); price
momentum In Newtonian mechanics, momentum (more specifically linear momentum or translational momentum) is the product of the mass and velocity of an object. It is a vector quantity, possessing a magnitude and a direction. If is an object's mass an ...
(a measure of market psychology); Realized Volatility (a measure of recent historical risk); High Yield Bond Returns (a measure of credit risk); and the
TED spread The TED spread is the difference between the interest rates on interbank loans and on short-term U.S. government debt ("T-bills"). TED is an acronym formed from ''T-Bill'' and ''ED'', the ticker symbol for the Eurodollar futures contract. Init ...
(a measure of systemic financial risk). Each of these factors provides a measure of market sentiment through a unique lens, and together they may offer a more robust indicator of market sentiment.
Closed-end fund A closed-end fund (CEF) is a fund that raises capital by issuing a fixed number of shares which are not redeemable, and then invest that capital in financial assets such as stocks and bonds. Unlike open-end funds, new shares in a closed-end fund ...
discount (the case when net asset value of a mutual fund does not equal to its market price) reported to be possible measure of investor attention (Zweig (1973) and Lee ''et al.'' (1991)). The studies suggest that changes in discounts of closed-end funds are highly correlated with fluctuations in investor sentiment. Brown ''et al.'' (2003) investigate daily
mutual fund A mutual fund is a professionally managed investment fund that pools money from many investors to purchase securities. The term is typically used in the United States, Canada, and India, while similar structures across the globe include the SICAV i ...
flow as possible measure of investor attention. According to Da ''et al.'' (2014), "...individual investors switch from equity funds to bond funds when negative sentiment is high."
Dividend A dividend is a distribution of profits by a corporation to its shareholders. When a corporation earns a profit or surplus, it is able to pay a portion of the profit as a dividend to shareholders. Any amount not distributed is taken to be re-in ...
premium (the difference between the average book-to-market ratios of dividend paying and not paying stocks) potentially can be a good predictor for investor sentiment (Baker & Wurgler (2004) and Vieira (2011)).
Retail investor There are two basic financial market participant distinctions, investor vs. speculator and institutional vs. retail. Action in financial markets by central banks is usually regarded as intervention rather than participation. Supply side vs. ...
trades data is also reported to be able to represent investor attention (Kumar & Lee (2006)). The study shows that retail investor transactions "...are systematically correlated — that is, individuals buy (or sell) stocks in concert".
Initial public offering An initial public offering (IPO) or stock launch is a public offering in which shares of a company are sold to institutional investors and usually also to retail (individual) investors. An IPO is typically underwritten by one or more investment ...
(IPO) of a company generates a big amount of information that can potentially be used to proxy investor sentiment. Ljungqvist ''et al.'' (2006) and Baker & Wurgler (2007) report IPO first-day returns and IPO volume the most promising candidates for predicting investor attention to a particular stock. It is not surprising that high investments in advertisement of a particular company results in a higher investor attention to corresponding stock (Grullon ''et al.'' (2004)). The authors in Chemmanur & Yan (2009) provide an evidence that "...a greater amount of advertising is associated with a larger stock return in the advertising year but a smaller stock return in the year subsequent to the advertising year". Equity issues over total new issues ratio,
insider trading Insider trading is the trading of a public company's stock or other securities (such as bonds or stock options) based on material, nonpublic information about the company. In various countries, some kinds of trading based on insider information ...
data, and other financial indicators are reported in Baker & Wurgler (2007) to be useful in investor attention measurement procedure. The aforementioned market-based measures have one important drawback. In particular, according to Da ''et al.'' (2014): "Although market-based measures have the advantage of being readily available at a relatively high frequency, they have the disadvantage of being the equilibrium outcome of many economic forces other than investor sentiment." In other words, one can never be sure that a particular market-based indicator was driven due to investor attention. Moreover, some indicators can work pro-cyclical. For example, a high
trading volume In capital markets, volume, or trading volume, is the amount (total number) of a security (or a given set of securities, or an entire market) that was traded during a given period of time. In the context of a single stock trading on a stock exchang ...
can draw an investor attention. As a result, the trading volume grows even higher. This, in turn, leads to even bigger investor attention. Overall, market-based indicators are playing a very important role in measuring investor attention. However, an investor should always try to make sure that no other variables can drive the result.


Second way

The second way to proxy for investor attention can be to use ''survey-based sentiment indexes''. Among most known indexes should be mentioned
University of Michigan Consumer Sentiment Index The University of Michigan Consumer Sentiment Index is a consumer confidence index published monthly by the University of Michigan. The index is normalized to have a value of 100 in the first quarter of 1966. Each month at least 500 telephone inte ...
, The Conference Board Consumer Confidence Index, and UBS/Gallup Index of Investor Optimism. The University of Michigan Consumer Sentiment Index is based on at least 500 telephone interviews. The survey contains fifty core questions. The Consumer Confidence Index has ten times more respondents (5000 households). However, the survey consists of only five main questions concerning business, employment, and income conditions. The questions can be answered with only three options: "positive", "negative" or "neutral". A sample of 1000 households with total investments equal or higher than $10,000 are interviewed to construct UBS/Gallup Index of Investor Optimism. Mentioned above survey-based sentiment indexes were reported to be good predictors for financial market indicators (Brown & Cliff (2005)). However, according to Da ''et al.'' (2014), using such sentiment indexes can have significant restrictions. First, most of the survey-based data sets are available at weekly or monthly frequency. At the same time, most of the alternative sentiment measures are available at a daily frequency. Second, there is a little incentive for respondents to answer question in such surveys carefully and truthfully (Singer (2002)). To sum up, survey-based sentiment indexes can be helpful in predicting financial indicators. However, the usage of such indexes has specific drawbacks and can be limited in some cases.


Third direction

Under the third direction, researchers propose to use
text mining Text mining, also referred to as ''text data mining'', similar to text analytics, is the process of deriving high-quality information from text. It involves "the discovery by computer of new, previously unknown information, by automatically extract ...
and
sentiment analysis Sentiment analysis (also known as opinion mining or emotion AI) is the use of natural language processing, text analysis, computational linguistics, and biometrics to systematically identify, extract, quantify, and study affective states and subjec ...
algorithms to extract information about investors’ mood from social networks, media platforms, blogs, newspaper articles, and other ''relevant sources of textual data'' (sometimes referred as news analytics). A thread of publications (Barber & Odean (2008), Dougal ''et al.'' (2012), and Ahern & Sosyura (2015)) report a significant influence of financial articles and sensational news on behavior of stock prices. It is also not surprising, that such popular sources of news as
Wall Street Journal ''The Wall Street Journal'' is an American business-focused, international daily newspaper based in New York City, with international editions also available in Chinese and Japanese. The ''Journal'', along with its Asian editions, is published ...
,
New York Times ''The New York Times'' (''the Times'', ''NYT'', or the Gray Lady) is a daily newspaper based in New York City with a worldwide readership reported in 2020 to comprise a declining 840,000 paid print subscribers, and a growing 6 million paid d ...
or
Financial Times The ''Financial Times'' (''FT'') is a British daily newspaper printed in broadsheet and published digitally that focuses on business and economic current affairs. Based in London, England, the paper is owned by a Japanese holding company, Nik ...
have a profound influence on the market. The strength of the impact can vary between different columnists even inside a particular journal (Dougal ''et al.'' (2012)). Tetlock (2007) suggests a successful measure of investors’ mood by counting the number of "negative" words in a popular Wall Street Journal column "Abreast of the market". Zhang ''et al.'' (2011) and Bollen ''et al.'' (2011) report
Twitter Twitter is an online social media and social networking service owned and operated by American company Twitter, Inc., on which users post and interact with 280-character-long messages known as "tweets". Registered users can post, like, and ...
to be an extremely important source of sentiment data, which helps to predict stock prices and volatility. The usual way to analyze the influence of the data from micro-blogging platforms on behavior of stock prices is to construct special mood tracking indexes. The easiest way would be to count the number of "positive" and "negative" words in each relevant tweet and construct a combined indicator based on this data. Nasseri ''et al.'' (2014) reports the predictive power of StockTwits (Twitter-like platform specialized on exchanging trading-related opinions) data with respect to behavior of stock prices. An alternative, but more demanding, way is to engage human experts to annotate a large number of tweets with the expected stock moves, and then construct a machine learning model for prediction. The application of the event study methodology to Twitter mood shows significant correlation to cumulative abnormal returns (Sprenger ''et al.'' (2014), Ranco ''et al. (2015)'', Gabrovšek ''et al.'' (2017)). Karabulut (2013) reports
Facebook Facebook is an online social media and social networking service owned by American company Meta Platforms. Founded in 2004 by Mark Zuckerberg with fellow Harvard College students and roommates Eduardo Saverin, Andrew McCollum, Dustin M ...
to be a good source of information about investors’ mood. Overall, most popular social networks, finance-related media platforms, magazines, and journals can be a valuable source of sentiment data, summarized in Peterson (2016). However, important to notice that it is relatively more difficult to collect such type of data (in most cases a researcher needs a special software). In addition, analysis of such data can also require deep
machine learning Machine learning (ML) is a field of inquiry devoted to understanding and building methods that 'learn', that is, methods that leverage data to improve performance on some set of tasks. It is seen as a part of artificial intelligence. Machine ...
and data mining knowledge (Hotho ''et al.'' (2005)).


Fourth road

The fourth road is an important source of information about investor attention is the ''Internet search behavior of households.'' This approach is supported by results from Simon (1955), who concludes that people start their decision making process by gathering relevant information. Publicly available data on search volumes for most Internet search services starts from the year 2004. Since that time many authors showed the usefulness of such data in predicting investor attention and market returns (Da ''et al.'' (2014), Preis ''et al.'' (2013), and Curme ''et al.'' (2014)). Most studies are using
Google Trends Google Trends is a website by Google that analyzes the popularity of top web search query, search queries in Google Search across various regions and languages. The website uses graphs to compare the search volume of different queries over time. ...
(GT) service in order to extract search volume data and investigate investor attention. The usefulness of Internet search data was also proved based on Yahoo! Corporation data (Bordino ''et al.'' (2012)). The application of Internet search data gives promising results in solving different financial problems. The authors in Kristoufek (2013b) discuss the application of GT data in
portfolio diversification In finance, diversification is the process of allocating capital in a way that reduces the exposure to any one particular asset or risk. A common path towards diversification is to reduce risk or volatility by investing in a variety of assets. I ...
problem. Proposed in the paper diversification procedure is based on the assumption that the popularity of a particular stock in Internet queries is correlated with the riskiness of this stock. The author reports that such diversification procedure helps significantly improve portfolio returns. Da ''et al.'' (2014) and Dimpfl & Jank (2015) investigate a predictive power of GT data for two most popular volatility measures: realized volatility (RV) and CBOE daily market volatility index (
VIX VIX is the ticker symbol and the popular name for the Chicago Board Options Exchange's CBOE Volatility Index, a popular measure of the stock market's expectation of volatility based on S&P 500 index options. It is calculated and disseminated ...
). Both studies report positive and significant dependence between Internet search data and volatility measures. Bordino ''et al.'' (2012) and Preis ''et al.'' (2010) reveal the ability of Internet search data to predict trading volumes in the US stock markets. According to Bordino ''et al.'' (2012), "...query volumes anticipate in many cases peaks of trading by one day or more." Some researchers find the usefulness of GT data in predicting volatility on foreign currency market (Smith (2012)). An increasingly important role of Internet search data is admitted in
cryptocurrency A cryptocurrency, crypto-currency, or crypto is a digital currency designed to work as a medium of exchange through a computer network that is not reliant on any central authority, such as a government or bank, to uphold or maintain it. It i ...
(e.g.
Bitcoin Bitcoin ( abbreviation: BTC; sign: ₿) is a decentralized digital currency that can be transferred on the peer-to-peer bitcoin network. Bitcoin transactions are verified by network nodes through cryptography and recorded in a public distr ...
) prices forecasting (Kristoufek (2013a)). Google Trends data is also reported to be a good predictor for daily
mutual fund A mutual fund is a professionally managed investment fund that pools money from many investors to purchase securities. The term is typically used in the United States, Canada, and India, while similar structures across the globe include the SICAV i ...
flows. Da ''et al.'' (2014) concludes that such type of sentiment data "...has significant incremental predictive power for future daily fund flow innovations of both equity and bond funds." One more promising source of Internet search data is the number of visits of finance-related Wikipedia pages (Wikipedia page statistics) (Moat ''et al.'' (2013) and Kristoufek (2013a)). To sum up, the Internet search behavior of households is relatively new and promising proxy for investor attention. Such type of sentiment data does not require additional information from other sources and can be used in scientific studies independently.


Fifth source

Finally the fifth source of investor attention can also depend on some ''non-economic factors''. Every day many non-economic events (e.g. news, weather, health condition, etc.) influence our mood, which, in term, influence the level of our
risk aversion In economics and finance, risk aversion is the tendency of people to prefer outcomes with low uncertainty to those outcomes with high uncertainty, even if the average outcome of the latter is equal to or higher in monetary value than the more ce ...
and trading behavior. Edmans ''et al.'' (2007) discuss the influence of sport events on investors’ trading behavior. The authors report a strong evidence of abnormally negative stock returns after losses in major soccer competitions. The loss effect is also valid after international cricket, rugby, and basketball games. Kaplanski & Levy (2010) investigate the influence of bad news (aviation disasters) on stock prices. The authors conclude that a bad piece of news (e.g. about aviation disaster) can cause significant drop in stock returns (especially for small and risky stocks). The evidence that the number of sunlight minutes in a particular day influence the behavior of a trader is presented in Akhtari (2011) and Hirshleifer & Shumway (2003). The authors conclude that the "sunshine effect" is statistically significant and robust to different model specifications. The influence of temperature on stock returns is discussed in Cao & Wei (2005). According to the results in the mentioned study, there is a negative dependence between temperature and stock returns on the whole range of temperature (i.e. the returns are higher when the weather is cold). A
seasonal affective disorder Seasonal affective disorder (SAD) is a mood disorder subset, in which people who have normal mental health throughout most of the year exhibit depressive symptoms at the same time each year. Common symptoms include sleeping too much, having li ...
(SAD) is also known to be a predictor of investors’ mood (Kamstra ''et al.'' (2003)). This is an expected result because SAD incorporates the information about weather conditions. Some researchers go even further and reveal the dependence between
lunar phase Concerning the lunar month of ~29.53 days as viewed from Earth, the lunar phase or Moon phase is the shape of the Moon's directly sunlit portion, which can be expressed quantitatively using areas or angles, or described qualitatively using the t ...
s and stock market returns (Yuan ''et al.'' (2006)). According to Dichev & Janes (2001): "...returns in the 15 days around new moon dates are about double the returns in the 15 days around full moon dates". Even geomagnetic activity is reported to have an influence (negatively correlated) on stock returns (C. Robotti (2003). To sum up, non-economic events have a significant influence on trader's behavior. An investor would expect high market returns on a sunny, but cool day, fifteen days around a new moon, with no significant geomagnetic activity, preferably the day after a victory on a significant sport event. In most cases such data should be treated as supplemental in measuring investor attention, but not as totally independent one.


Currency markets

Additional indicators exist to measure the sentiment specifically on
Forex The foreign exchange market (Forex, FX, or currency market) is a global decentralized or over-the-counter (OTC) market for the trading of currencies. This market determines foreign exchange rates for every currency. It includes all as ...
markets. Though the Forex market is decentralized (not traded on a central exchange), various retail Forex brokerage firms publish positioning ratios (similar to the Put/Call ratio) and other data regarding their own clients' trading behavior. Since most retail currency traders are unsuccessful, measures of Forex market sentiment are typically used as
contrarian A contrarian is a person who holds a contrary position, especially a position against the majority. Investing A contrarian investing style is based on identifying, and speculating against, movements in stock prices that reflect changes in th ...
indicators. Some researchers report Internet search data (e.g.
Google Trends Google Trends is a website by Google that analyzes the popularity of top web search query, search queries in Google Search across various regions and languages. The website uses graphs to compare the search volume of different queries over time. ...
) to be useful in predicting volatility on foreign currency markets. Internet search data and (relevant) Wikipedia page views data are reported to be useful in
cryptocurrency A cryptocurrency, crypto-currency, or crypto is a digital currency designed to work as a medium of exchange through a computer network that is not reliant on any central authority, such as a government or bank, to uphold or maintain it. It i ...
(e.g.
Bitcoin Bitcoin ( abbreviation: BTC; sign: ₿) is a decentralized digital currency that can be transferred on the peer-to-peer bitcoin network. Bitcoin transactions are verified by network nodes through cryptography and recorded in a public distr ...
) prices forecasting.


See also

* Acertus Market Sentiment Indicator (AMSI) *
Market trend A market trend is a perceived tendency of financial markets to move in a particular direction over time. Analysts classify these trends as ''secular'' for long time-frames, ''primary'' for medium time-frames, and ''secondary'' for short time-fram ...
*
Pivot point (stock market) In financial markets, a pivot point is a price level that is used by traders as a possible indicator of market movement. A pivot point is calculated as an average of significant prices (high, low, close) from the performance of a market in the p ...
*
Sentiment analysis Sentiment analysis (also known as opinion mining or emotion AI) is the use of natural language processing, text analysis, computational linguistics, and biometrics to systematically identify, extract, quantify, and study affective states and subjec ...
*
Behavioral economics Behavioral economics studies the effects of psychological, cognitive, emotional, cultural and social factors on the decisions of individuals or institutions, such as how those decisions vary from those implied by classical economic theory. ...
*
Behavioral portfolio theory Behavioral portfolio theory (BPT), put forth in 2000 by Shefrin and Statman,SHEFRIN, H., AND M. STATMAN (2000): "Behavioral Portfolio Theory," ''Journal of Financial and Quantitative Analysis'', 35(2), 127–151. provides an alternative to the assu ...
* Behavioral Strategy


References

{{DEFAULTSORT:Market Sentiment Stock market Behavioral finance