Saturday, September 22, 2007

Keeping Tabs on Stock Market Sentiment

I observed a while back that the traffic statistics for this blog seem to be reflective of market sentiment. During the brief March plunge and especially during the August weakness, the traffic to this site expanded significantly. I found that these increases were not related to external sites linking to mine. Indeed, I could even track sensitivity to market conditions hour-by-hour: during very weak intraday periods, traffic for that hour expanded well above its norm.

Conversely, during July--prior to the market decline--I noticed a distinct dropoff in visits to the site. On slow market days such as Friday, I also notice less blog traffic.

Since mentioning these patterns, other market bloggers have contacted me and mentioned that they've observed similar phenomena. It appears that, during periods of high market uncertainty and volatility, one way that traders and investors cope is to seek information. This manifests itself in increased Web surfing of blogs and other sites that post in a timely fashion.

The reason I bring this up is that, even apart from the slow day on Friday, I've noticed that my traffic statistics are looking more like early July and less like August. Traders don't seem to be reaching out for information in the frantic way that they had been doing during the market decline.

I decided to examine the five-day equity put-call ratio (see chart above) and plot it against the S&P 500 Index (SPY). Sure enough, the put/call ratio has also tailed off as the market has turned around. Option-related sentiment is not far off its early July levels. The put-call ratio has closely followed the traffic patterns on the blog.

Does this mean the market is headed for a sustained decline? Not necessarily. What I've found is that the combination of a weakening market (fewer stocks making fresh 20-day highs; fewer stocks trading above their 50 day moving averages; fewer stocks closing above their volatility envelopes; reduced levels of Cumulative Adjusted NYSE TICK) and bullish market sentiment is the setup for a meaningful correction.

Thus far, during the past week, we've seen solid strength in these indicators (which I track daily in my Twitter comments and summarize weekly in my Trading Psychology Weblog). It's when we see sustained divergences that we want to be lightening our exposure to stocks.


Sentiment and Short-Term Cycles

Cumulative TICK as Sentiment Measure

What Drives Investor Sentiment?