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The Foundation for the Study of Cycles is a registered 501(c)(3) non-profit educational institution. Your contribution is tax-deductible to the extent permitted.
Donate by Mail
Foundation for the Study of Cycles, PO Box 177, Floyd, VA 24091
Tax information
Foundation for the Study of Cycles is registered as a 501(c)(3) non-profit organization. Contributions to the FSC are tax-deductible to the extent permitted by law. The Foundation’s tax identification number is 83-2540831.
Blog
April 22, 2024News
Recurrent Patterns in “Small Trader” Stock Futures Market Sentiment: A Working Hypothesis Part 2
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.
