Sentiment Indicators

When the crowd is the signal

Most indicators measure price or volume — what the market is doing. Sentiment indicators measure something different: what market participants think the market will do. And the central insight, documented by Pring, Elder, and decades of market history, is brutally counterintuitive: the crowd is usually wrong at extremes.

Pring explains the logic:

When a significant number of traders are bullish on a particular market, they are already positioned on the long side. That means there is very little potential buying power left. — Pring, Technical Analysis Explained

If almost everyone who might buy has already bought, there's no one left to push prices higher. The only direction is down. The reverse applies at fear extremes — when almost everyone has sold, there's no one left to sell, and any catalyst can trigger a rally.

The contrarian framework

Pring advocates using multiple sentiment indicators together:

Use of three or four indexes that measure sentiment is useful from the point of view of assessing the majority view, from which a contrary opinion can be taken. — Pring, Technical Analysis Explained

No single sentiment gauge is reliable on its own. But when multiple independent measures all scream "extreme bullishness" (or "extreme bearishness") simultaneously, the contrarian signal strengthens.

Here are the major sentiment tools:

Investors Intelligence (advisory sentiment)

Pring describes this as one of the oldest and most-watched sentiment surveys:

Investors Intelligence has been compiling data on the opinions of publishers of market letters. The evidence suggests that the advisory services in aggregate act in a manner completely opposite to that of the majority. — paraphrased from Pring, Technical Analysis Explained

The survey classifies newsletter writers as bullish, bearish, or expecting a correction. Historically:

• 60%+ bulls: market top risk — the advisors have used up their buying power.
• 30% or fewer bulls (many bears): market bottom zone — extreme pessimism is fuel for a rally.
• The "correction" camp is less useful — it reflects uncertainty rather than conviction.

This works because newsletter writers, despite being professionals, are reactive — they become bullish after rallies (too late) and bearish after declines (too late again).

The VIX (fear gauge)

The CBOE Volatility Index measures the market's expectation of 30-day volatility, derived from S&P 500 option prices. It's commonly called the "fear index" because it spikes when put demand surges and investors pay up for downside protection.

Contrarian reading:

• VIX above 30–40: High fear, heavy hedging. Historically associated with market bottoms.
• VIX below 12–15: Extreme complacency. Historically associated with market tops or pre-correction environments.

The VIX doesn't give precise timing — it can stay elevated for weeks during a crisis. But extreme VIX spikes (above 40) have historically marked major bottoms: March 2009, March 2020, October 2008.

The put/call ratio

Compares the number of put options traded to call options. More puts than calls = hedging = fear. More calls than puts = speculation = greed.

Elder emphasizes that the stock market's structural long bias means there's always a baseline imbalance:

While the numbers of futures and options contracts held long and short is equal by definition, in the stock market there is always a huge disparity between the two camps. — Elder, The New Trading for a Living

A rising put/call ratio means fear is increasing. A falling ratio means complacency is growing. Like the VIX, extreme readings are contrarian signals:

• Put/call above 1.0–1.2: Heavy put buying = fear extreme → contrarian bullish.
• Put/call below 0.5–0.6: Heavy call buying = greed extreme → contrarian bearish.

The equity-only put/call ratio (excluding index options) is considered a cleaner read of retail sentiment.

Short interest

Short interest measures the total number of shares sold short across the market or in a specific stock. High short interest means many traders are betting on a decline.

The contrarian logic: heavily shorted stocks have built-in buying pressure. If the stock rises, short sellers must buy to cover their positions, creating a short squeeze that accelerates the rally. Extreme aggregate short interest across the market can signal a pessimism extreme — fuel for a rally.

Magazine covers and media extremes

Elder makes a point about popular media as a sentiment tool:

Markets offer enormous temptations. Markets provoke great surges of greed and even greater waves of fear. — Elder, The New Trading for a Living

When a financial topic dominates mainstream media — magazine covers declaring "The Death of Equities" or "This Market Can Only Go Up" — it's a reliable contrarian signal. By the time a trend is Magazine Cover news, the smart money has already acted. The crowd is the last to arrive and the first to get hurt.

Classic examples:

• BusinessWeek "The Death of Equities" — August 1979. Near the start of an 18-year bull market.
• Time "Home Sweet Home" — June 2005. Near the peak of the housing bubble.
• "Bitcoin to Zero" headlines — December 2018. Near the cycle bottom.

How to use sentiment practically

1. Track 3–4 indicators simultaneously. VIX, put/call ratio, Investors Intelligence, and AAII (individual investor survey). When all four hit extremes in the same direction, pay attention.

2. Sentiment is a condition, not a trigger. Extreme bullish sentiment tells you the market is vulnerable to a selloff — it doesn't tell you when. You still need a price trigger (breakdown below support, bearish divergence, etc.).

3. Combine with breadth. Extreme bullish sentiment + deteriorating breadth (A/D divergence) is the highest-conviction topping combination. Extreme bearish sentiment + improving breadth is the buying setup.

4. Be aware of regime. In secular bull markets, bullish sentiment can stay elevated longer than contrarians expect. In secular bear markets, bearish sentiment can persist. Extremes are relative to the current regime, not absolute.

Quick check

What you now know

• Sentiment indicators measure what the crowd thinks, and the crowd is wrong at extremes.
• Investors Intelligence: 60%+ bulls = top risk; heavy bears = bottom zone.
• VIX: above 30–40 = fear extreme (contrarian bullish); below 12–15 = complacency (contrarian bearish).
• Put/call ratio: above 1.0 = fear; below 0.5 = greed. Both are contrarian signals.
• Short interest: creates built-in buying pressure (short squeeze potential).
• Sentiment is a condition, not a trigger — combine with price action and breadth for timing.

Next: Adaptive Techniques — Kaufman's adaptive moving average (KAMA), the efficiency ratio, and systems that automatically adjust to market noise.