by Jake Bernstein, FSC Board Member
Successful trading and investing are based on consistency, patterns, and effective risk management, as well as investor application of strategy, related rules, and procedures.
For many years, traders and investors have relied on traditional patterns, such as support and resistance lines, and various market geometry formations (Elliott wave, Fibonacci, etc.). In my estimation, relatively few traders understand or appreciate the consistency of repetitive seasonal patterns.
The chart below is a weekly seasonal composite chart of the Dow Jones Industrial Average. The chart does not represent any single year; rather it displays the typical year. We have done this by normalizing the data. We have converted the high of each year to 100 and the low of each year to zero to extract what, for lack of a better term, I would call market DNA. I believe the stock chart speaks for itself. It covers over a century of data.
As a prediction tool it suggests October, November and December are the strongest part of each year. Take some time and study the chart. What do you think? Remember, the chart is only a guide. Every year is different and timing indicators must be used in order to jump on the trend with success.
Jake Bernstein, FSC Board Member
Jake Bernstein has been publishing Jake Bernstein's Weekly Futures Trading Letter since 1972 and trading futures and stocks since 1968. His forecasts and opinions are quoted regularly in the financial press and on financial websites, and he is frequently interviewed on radio and television throughout the U.S. and Canada, including Wall Street Week, CNBC, JagFN.TV, and WebTV.com. In addition to speaking extensively in the U.S., Canada, Europe, and Asia, Bernstein is a consultant for investors, traders, industry, financial institutions, short-term traders, brokerage firms, and commercial firms. Floor traders, professional traders, money managers, hedgers, and traders, both new and experienced, subscribe to his market advisory services. Bernstein is based in California, U.S.
Case Study S&P Futures
by Jacob Bernstein, FSC Board Member
© 2024
Abstract
In Part 1 of this informal study, we examined several charts showing the relationship between price tops and price bottoms and my measure of small trader sentiment, the Daily Sentiment Index (DSI). In Part 2, we cited several examples with charts illustrating the relationship between small trader market sentiment and price peaks and troughs and several futures markets. A visual examination led me to the following preliminary conclusions:
- Elevated levels of small trader sentiment (80% or higher) tended to precede or correlate closely with market peaks.
- Low levels of small trader sentiment (20% or lower) tended to precede or correlate closely with market lows.
- The observed correlations were sufficiently strong to warrant further investigation on a case-by-case basis to determine whether small trader sentiment was sufficiently reliable to be of value in trading and/or investing, which is the objective of this report.
Market
For this case study I selected S&P 500 futures. Given that the S&P 500 is one of the most actively traded futures markets and certainly one of the most widely followed markets internationally, it was an obvious choice for a more detailed examination. Indeed, other markets such as treasury bond futures, crude oil futures, or one of the precious metals have strong international participation. However, S&P futures are more reactive to geopolitical and fundamental economic concerns and would therefore appear to be an ideal candidate for closer investigation.
Methodology and Preliminary Observations
For this investigation, I examined the monthly S&P futures/sentiment chart for the period 2001 through 2024 (Figure 1). The sentiment data was slowed with a three period SMA to stabilize the occasional but often brief “erratic” small trader reaction to news events. Examination of the data suggest that the relationship between small trader sentiment and significant market tops and bottoms is reliable and indicative of predictive ability. I made the following assumptions in reaching the conclusions summarized below.
- Sentiment readings of 80% or > = expect market decline
- Sentiment readings of 25% or < = expect market rally
- 80% or > points marked with vertical yellow line
- 25% or < points marked with vertical green line
- Green arrow up = "correct" correlation or forecast of low
- Red arrow down = "correct" correlation or forecast of high
Preliminary Conclusions
Figure 1 contains considerable data. Please study it carefully. I reach the following conclusions, which may be subject to some degree of interpretation given that I have taken some liberties in defining "significant" price and sentiment levels. I note that this examination is still in its initial stages.
- There were 8 significant monthly lows, every one of which was followed by a price increase. Low small trader sentiment was a leading indicator supporting the concept of small trader bearish sentiment as a valid contrary opinion indicator of bottoms
- There were 8 significant monthly highs, 7 of which were followed by a price decrease. High small trader sentiment was a leading indicator supporting the concept of small trader bullish sentiment as a valid contrary opinion indicator of tops.
Stay tuned for more to follow.
Jake Bernstein, FSC Board Member
Jake Bernstein has been publishing Jake Bernstein's Weekly Futures Trading Letter since 1972 and trading futures and stocks since 1968. His forecasts and opinions are quoted regularly in the financial press and on financial websites, and he is frequently interviewed on radio and television throughout the U.S. and Canada, including Wall Street Week, CNBC, JagFN.TV, and WebTV.com. In addition to speaking extensively in the U.S., Canada, Europe, and Asia, Bernstein is a consultant for investors, traders, industry, financial institutions, short-term traders, brokerage firms, and commercial firms. Floor traders, professional traders, money managers, hedgers, and traders, both new and experienced, subscribe to his market advisory services. Bernstein is based in California, U.S.
Correlations: Leading, Lagging and Concurrent Indicators
by Jacob Bernstein, FSC Board Member
© 2024
What follows in Part 2 of this report is not a scientific or statistically rigorous examination of the working theory that the “small trader” as a group is usually incorrect at “significant” stock market tops and bottoms. Even at this early stage of my investigation, a few definitions are in order; for example, who is the “small trader?” Additionally, what constitutes a “significant” stock market top or a stock market bottom. Should we decide to investigate this potential relationship further, such definitions will become critically important, however, for this preliminary examination the general definitions I have chosen will suffice.
Please do note from the outset that my goal is not a scientific one but rather a pragmatic application. I am simply seeking to determine whether the small trader sentiment data I have collected daily since 1987 can be of value in trading or investing in the capital markets. In Part 1 we examined several charts showing the relationship between price tops and price bottoms and my measure of small trader sentiment, the Daily Sentiment Index (DSI). The visual examination led me to the following preliminary conclusions:
- High levels of small trader sentiment (80% or higher) tended to precede or correlate closely with market peaks
Low levels of small trader sentiment (20% or lower) tended to precede or correlate closely with market lows
Timing
The single most important issue for investors and traders is timing. Therefore, of the three types of timing indicators (leading, lagging, or concurrent) the most sought after and prized would be the leading indicator. Let’s take a quick look at a few of the most actively traded markets and their sentiment histories.
Figure 1 shows the DSI daily report data on Emini S&P f futures weekly data. Note that the DSI has been “slowed” with a 3 period simple moving average to stabilize its occasional erratic swings.
Figure 1: Weekly S&P futures vs. DSI. There were 4 significant weekly lows in S&P futures from September 2022 through March 2024. All 4 were closely correlated with or preceded by DSI at or below 20% bulls. During this period there were three significant price highs two of which were either accompanied by or preceded by DSI at or above 80%.
Figure 2: Weekly crude oil futures with DSI. There were three price lows all of which were closely correlated with DSI near or below 20%. There were three price tops two of which were closely correlated with 80% or higher DSI.
Figure 3: Weekly soybean futures vs. DSI. A series of DSI highs correlated closely with the January through March price top. Several low DSI readings preceded the very large up move in soybean futures in October 2021 through May 2022. Low DSI preceded two price lows.
Figure 4: Copper futures vs. DSI. DSI of approximately 80% correlated near perfectly with price highs. A series of low DSI readings correlated closely with a series of price lows.
Figure 5: Nasdaq futures correlated closely with several highs and lows in sentiment.
Preliminary Conclusions
I am not a statistician. I do not claim to have presented hard statistical evidence in support of my working hypothesis. However, this is still the first step in investigating a concept that has long been espoused by the trading community. This is my initial examination in my “does the concept have face validity?” phase of determining the potential value of small trader sentiment as a market timing/forecasting tool. More to follow.
Jake Bernstein, FSC Board Member
Jake Bernstein has been publishing Jake Bernstein's Weekly Futures Trading Letter since 1972 and trading futures and stocks since 1968. His forecasts and opinions are quoted regularly in the financial press and on financial websites, and he is frequently interviewed on radio and television throughout the U.S. and Canada, including Wall Street Week, CNBC, JagFN.TV, and WebTV.com. In addition to speaking extensively in the U.S., Canada, Europe, and Asia, Bernstein is a consultant for investors, traders, industry, financial institutions, short-term traders, brokerage firms, and commercial firms. Floor traders, professional traders, money managers, hedgers, and traders, both new and experienced, subscribe to his market advisory services. Bernstein is based in California, U.S.
Visual Inspection of the Concept
by Jacob Bernstein, FSC Board Member
© 2024
Abstract
Using a lengthy historical database of small trader sentiment in the stock and futures markets, we develop a working hypothesis in response to the question: Can small trader sentiment be used as a leading indicator and/or as a timing indicator for short-term, intermediate-term, and long-term trading? We discuss some of the inherent issues and offer a preliminary visual overview.
One of the most oft cited and universally believed epigrams about the stock market is that the small trader is always wrong. As in the case of most statements containing the term “always,” a red flag is invariably my first response. After many years of hearing the statement bandied about, primarily by professional traders, I concluded in the early 1980s that such a dogmatic statement warranted further investigation. Indeed, if the small trader (whoever that might be and however that might be defined) was always wrong, they wouldn’t play the game. However, if the small trader was right even a small percentage of the time at or in advance of critical market turning points, their actions could be useful as part of a trading strategy based on contrary opinion. Furthermore, a contrary opinion strategy or indicator might be developed as a “silver lining,” dependent upon the validity of this assumption. Naturally, a scientific or even quasi scientific approach to testing the validity and pragmatic issues of this assumption would be necessary prior to putting money at risk. This brief overview presents a working hypothesis of small trader sentiment as a contrary opinion market indicator in stocks and futures and provides some initial chart-based visuals of the concept.
A Brief History
The primary issue involved in testing the concept would be acquiring or developing a consistent database of small trader sentiment. In 1987, a former business partner and I initiated an informal daily survey of what we considered to be small traders in the futures markets. It became apparent that the database of respondents was constantly changing, since some people dropped in and out of the survey and others dropped out entirely. Over the course of several years, we solved that issue and began to collect what we considered to be a stable measure of smart trader sentiment.
Initially, our survey was conducted by telephone and fax machine, however, with the growth of the internet and email, we developed a procedure (currently proprietary) for collecting daily sentiment. The Daily Sentiment Index (DSI) data collection has evolved significantly with the assistance of the internet and the speed of communications.
Once we had achieved a stable respondent base, it became evident that the small trader had an uncanny ability to be the most bullish at or in advance of market tops and most bearish at or in advance of market bottoms. These two relationships became more pronounced the stronger the consensus of opinion was in one direction or another.
In the mid 1980s, a number of hedge funds and brokerage firms became aware of the sentiment index and requested subscriptions to the service. Many professional traders were impressed with its use as a contrary opinion indicator. Today, the list of DSI subscribers reads like a who's who of hedge funds. The update is a paid subscription model but note that this article is not intended to promote sales. We have made it our policy for many years not to advertise the DSI. Certainly, any individual with even the slightest market knowledge can develop their own survey.
General Observations
The DSI is presented daily in several formats. I do not provide instructions on the use of the data. That is up to the individual. However, during these days of massive demands for data, the DSI historical database is a prime candidate for deeper investigation using AI models of various types. Showing below (Fig. 1) is the daily report showing the raw data percent bullish response, the futures market name, and various moving average manipulations of the raw data.
Here are some very general conclusions about the DSI based solely on a visual comparison of price vs. DSI trends and extremes. I have included a number of price charts with the DSI on the lower part of the charts. I have marked some significant points (vertical lines) to illustrate the concept. Note that the raw DSI has been slowed with a small simple moving average in order to smooth a frequently volatile small trader response to market volatility.
- Raw DSI readings of 80% or higher tend to correlate with and or lead market tops
- DSI readings of 20% or lower tend to correlate with and or lead market bottoms
- DSI sentiment tends to correlate with market direction except at extreme sentiment readings
Figure 1: The DSI daily report
Conclusions
I am not a statistician. I do not claim to have presented hard statistical evidence in support of my working hypothesis. However, this is the first step in investigating a concept that has long been espoused by the trading community. Unfortunately, there have been no hard statistical tests of the pervasive belief that the small trader is always wrong. This initial examination is the first step in the process of determining the veracity of this widely held belief. But moreover can we employ the concept as a contrary opinion timing indicator? More to follow.
Jake Bernstein, FSC Board Member
Jake Bernstein has been publishing Jake Bernstein's Weekly Futures Trading Letter since 1972 and trading futures and stocks since 1968. His forecasts and opinions are quoted regularly in the financial press and on financial websites, and he is frequently interviewed on radio and television throughout the U.S. and Canada, including Wall Street Week, CNBC, JagFN.TV, and WebTV.com. In addition to speaking extensively in the U.S., Canada, Europe, and Asia, Bernstein is a consultant for investors, traders, industry, financial institutions, short-term traders, brokerage firms, and commercial firms. Floor traders, professional traders, money managers, hedgers, and traders, both new and experienced, subscribe to his market advisory services. Bernstein is based in California, U.S.