BASIC TECHNIQUES
Weather Vane For The Market
Bullish Consensus
by David Penn
This enduring sentiment indicator was designed specifically for the
futures markets.
"Paradox is one of the deepest and most important secrets of life,
and ... irony is the punishment for not having understood that."
-James Dines, How Investors Can Make Money
Using Mass Psychology
During times of confusion in the markets, studies
of market sentiment tend to become popular. This is probably unfortunate.
It is the absence of a clear, distinct trend that forces uncertain market
players to look away from their indicators and trendlines, their oscillators,
and their cycles for something -- anything -- that can explain why the
markets are acting the way they are. For many traders, a peek at what the
smart money is doing is often an irresistible salve against the confusion
of a marketplace that seems incapable of making up its mind.
Why "unfortunate"? I say this because during trading ranges,
the "smart" money is often no more convinced of its next position
than the "dumb" money. As Marc Faber noted in his excellent short
essay, "Timing Your Leap Into the Unpopular," "At most major
turning points or milestones in financial history, the minds of most investors
are as if paralyzed."
This may be no less true of lesser turning points in the markets and
the economy. In fact, in some cases, when the smart money does in fact
have a strong opinion on the near-term direction of the market, it uses
trading ranges as accumulation and distribution areas, taking advantage
of the drop in volatility and lack of a long-term trend to reverse a position
or to add to a position discreetly. As a trend-follower might say, when
the market isn't really going anywhere, neither should you. Consolidations
and trading ranges are best not "gamed" -- they are best waited
out.
So when is market sentiment truly worth watching? The best time to begin
tracking sentiment is when that market appears to be reaching an extreme
point, a high or low that seems out of sync with market fundamentals or
price action (that is, a new high during a negative divergence in a key
indicator).
Because sentiment is most clearly read -- and most passionately felt
-- during market extremes, market sentiment is a particularly valuable
tool for those market players looking to take contrarian positions vis-à-vis
the market. While it is true that market sentiment can also be helpful
in keeping a trader on the right side of the market, it is the contrarian
character of sentiment analysis that is often the most telling use of this
market information.
...Continued in the November 2003 issue of Technical Analysis
of STOCKS & COMMODITIES
Excerpted from an article originally published in the November 2003
issue of Technical Analysis of STOCKS & COMMODITIES magazine. All rights
reserved. © Copyright 2003, Technical Analysis, Inc.
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