Those who have read the first two posts of The Argument for Sentiment Based Approach will have seen that those who argue for such an approach say that you must make the most of herd mentality. The next step is how to determine what the overriding market sentiment will be. This is where the task becomes trickier for those who advocate taking a sentiment based approach to trading. In Today’s post we are going to look at some of the suggested methods, those who endorse a sentiment based approach to trading adopt.
At first glance it may seem hard to understand how it’s possible to determine the sentiment of a market place without being right in the center of the action say on the trading floor or based within a trading firm. While being down in the action on the trading floor certainly would give you a good sense of the market sentiment there are also other ways to determine market sentiment. But mass media can give an indication into what the overriding sentiment in the market it is.
It is frequently argued that Magazine covers are one of the best indicators of mass psychology. It is argued that a major financial magazine would not devote its front cover to a particular story if that story was either not extremely important or was of particular interest to it’s reader. These covers therefore are meant to express examples of extreme sentiment. Studies haves been down suggesting that often a contrarian approach should be taken towards Magazine covers that take a directional stance on market. A particular famous example of such a contrarian magazine cover was Business Weeks 1979 cover proclaiming The Death of Equities. Which came at a point when stocks were near there cheapest since the Second World War, the cover was followed with one of the strongest Bull markets in the 20th Century. A study of this phenomenon was undertaken in 2007 by a group of Professors at the University of Richmond, Virginia. The study concluded that “positive feature stories headlined on business magazine covers follow extremely positive company performance and negative headlines follow extremely negative performance. In both cases, however, the appearance on a cover of Business Week, Fortune, or Forbes tends to signal the end of the extreme performance.”
Using News Headlines
Again some have argued that some News Headlines particularly those talking about performance in the previous day trading provide a great opportunity in the same way as Magazine covers. If a news headline talks about a companies poor performance in the day before the information that caused the significant downward movement has already been priced in before the headline has been published. Other types of news headlines such as breaking news will often not effect the market in the same way, with the market pricing in the breaking news.