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How to Use Sentiment Indicators to Time the Market
by Todd Bolen
http://www.tradersedge.us

One of our best calls this year was the October 10th,
2002 reversal that led to a 37% rise in the overall
markets. What did we see that allowed us to make this
call?

To bring you back, from August 22nd through October 9th,
the Dow was down 20%, the S&P; 500 sold off 21% and the
Nasdaq slid 22%. All the people on CNBC were talking about
the end of the world and doom and gloom. You could not find
anyone positive about the markets. However the indicators
we follow were telling us the downward move was coming to
an end.

In its simplest form, sentiment indicators measure extremes
in the market. When everyone is going one way, odds favor a
shift in the opposite direction. The indicators we follow
are the put/call ratio, newsletter writers, the VIX,
the "magazine indicator" and NYSE vs. NASDAQ volume ratio.
All of these indicators flash warnings signs at extreme
levels in the market and give you a hint of the coming
reversal.

Put/Call Ratio

Typically investors will buy call options when they are
optimistic on the market. Conversely, they will buy put
options when they anticipate it will fall. The put/call
ratio measures the number of puts bought for every call
bought. For example, when the indicator measures .67, this
is telling you that for every 1 call that was
purchased, .67 puts were purchased. This would tell you
that generally, people are more bullish than bearish. When
the put/call ratio spikes over 1.0, a warning flag is
raised. This indicates more people are becoming bearish,
which usually happens AFTER the big drop. It tells you the
market is nearing extremely oversold conditions. The
put/call ratio hit 1.12 on 9/18, 1.08 on 9/19, 1.05 on 9/20
and 1.0 on 10/9. Only two other times in 2002 did the ratio
measure over 1.0! By following this indicator daily, you
would have been alerted to the change in direction that
occurred October 10th. Use the put/call ratio as a guide
only. It is a SECONDARY indicator. In other words, just
because the ratio hits over 1.0, don't buy the market like
crazy. The indicator will give you a good idea of when the
selling is nearing an end for the near-term, but not the
exact point.

Newsletter Writers

Investors Intelligence is a company that tracks popular
newsletter writers across the country. They originally
thought if most writers were bullish, it would be a good
sign to be in the market. After years of studying these
writers, they found the opposite to be true. In other
words, when most newsletter writers were bullish, the
market soon thereafter fell. When most writers were
bearish, the market soon rallied.

So we watch the ratio of bullish to bearish newsletter
writers to look for extremes. Let's look at some examples:

~ In 1987, 61% of advisors were bullish up into the crash
in October. You know what happened next.

~ In 1990, during the recession, more than 55% of writers
were bearish. The Gulf War started and the market had a
tremendous run.

~ In 1994, right before the markets made another multi-year
run, bearish sentiment was 59%.

~ In February 2001, after the huge drop in 2000, newsletter
writers were still bullish. A full 62% of them, a 14-year
high, expected the market to rise. They were in for another
year of negative returns.

~ Care to guess were the newsletter writers were on October
9th, 2002? You guessed it, mainly bearish!

Follow this number daily. These extremes do not happen very
often, but when they do it is yet another quiver in your
cap telling you the market is about to reverse.

VIX Indicator

The VIX is a measurement of volatility. Very simply, it
measures the tone of selling which can get panicky near
market bottoms. When the indicator moves above the 40, and
especially above the 50 level, the market is very close to
reversing direction.

How did this indicator perform around October 9th?

~ 9/19 46.16

~ 9/24 45.38

~ 10/04 46.28

~ 10/07 49.18

~ 10/09 49.48

As you can see, the index started creeping up in late
September and finally capped out around the 50 level. The
selling was obviously extreme. Knowing this number,
combined with the put/call ratio and the newsletter
indicator would be a major indication to you the market was
about to reverse. By the way, it hit 49.04 on 9/21/2001
right before the markets staged a major 30% comeback rally.

Magazine Cover Indicator

This indicator is more difficult to monitor but simply be
aware of the covers on magazines. The writers report the
news after the fact and are notoriously late. Once you
start seeing bears on front covers and charts depicting
crashes, simply be aware. The worst is probably over. The
most famous example of this indicator is Business Week's
article titled "The Death of Equities" which was published
August 13th, 1973!

NYSE vs. Nasdaq Volume

You will notice around major market bottoms, the NYSE will
trade many more shares than the Nasdaq. Why does this
happen? When a bear market starts, investors will sell
shares of more speculative companies first. Later in the
process, they will come after the blue chip types of
companies thus causing the volume to increase on the NYSE.
The first time we saw this indicator pop up was on 9/24
about 2 ~ weeks before the reversal October 10th. It showed
up again on 10/04, which was the highest level in over 5
years! It finally showed itself on 10/07 and 10/08. These
were major clues of the coming move.

Following these indicators daily will help you "feel" when
the market is in extreme territory. You will be alerted
before the crowds of the coming reversal and can position
your portfolio accordingly.

This article courtesy of http://www.investment-index.com.
You may freely reprint this article on your website or in
your newsletter provided this courtesy notice and the author
name and URL remain intact.

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