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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.
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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
May 21, 2024News
Recurrent Patterns in “Small Trader” Stock Futures Market Sentiment: A Working Hypothesis Part 3
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.
