Permabulls always say everyone's bearish.
And permabears always say everyone's bullish.
Most of the time, neither actually gives evidence for their views.
That's why we started T3 Live's Weekly Sentiment Update.
Our Weekly Sentiment Update eliminates opinions, feelings, hunches, and preconceived notions.
That lets us strictly focus on the numbers and get a more accurate idea of just how bullish the crowd is.
To do this, we take 5 sentiment indicators, break each one down, and then analyze what they mean as a whole.
Simple — lone sentiment indicators contradict each other all the time.
At any given time, one sentiment indicator can read bullish, and another can read bearish.
So it's best to use a variety before forming an opinion.
And the 5 we use are all available to the general public without any expensive subscriptions.
Here they are, in no particular order:
1) VIX Curve
If you understand the basics of the VIX, then you probably know that the VIX alone is useless as a sentiment indicator. And it has little value as a predictor of price.
However, by comparing the spot price of the VIX to forward futures prices, you can get an idea of just how much volatility traders are pricing in.
For example, if the spot VIX price today is 20 and the 3-month future is 18, that means that traders are pricing in significant short-term volatility. That of course means they're bearish.
Click here for a detailed primer on the VIX Curve
2) CNN Fear & Greed Index
The CNN Fear & Greed Index uses a variety of factors including market momentum, junk bond demand, and market volatility to judge whether traders are more fearful (bearish) or greedy (bullish).
I'm a big fan of this index because it operates on a simple 0 (extreme fear) to 100 (extreme greed) scale, which eliminates a lot of guesswork.
If you're going to choose only 1 sentiment indicator to follow (which I don't recommend), this is probably the one to pick because it focuses on actual market activity than polls and surveys.
3) American Association of Individual Investors Sentiment Survey
Speaking of surveys, every Thursday, I look forward to the release of the AAII Sentiment Survey.
The AAII Sentiment Survey tells us whether individual investors are bullish, bearish, or neutral for the next 6 months. Since individual investors tend to get too bullish at tops and too bearish at bottoms, it's good to know where they stand.
AAII also provides in-depth commentary with its weekly Sentiment Survey data, which is very helpful in making comparisons to historical trends, and in figuring out what's actually driving public opinion on the market.
4) Chicago Board Options Exchange Equity Put-Call Ratio
The CBOE Equity Equity Put-Call Ratio tells us how many put options are traded vs. the number of calls.
Reported at the end of each day, the CBOE equity-put call gives us a rough idea of how equity options traders view the market.
On average, about 0.65 puts trade for each 1 call every day.
When we see major shifts from that long-term average, it can indicate an extreme in sentiment, and a potential trend change in the market.
5) ISE Sentiment Index
The ISE Sentiment Index is similar to the CBOE Put-Call ratio, but it has a few interesting twists to it.
While many options-derived sentiment indicators are put-call ratios, the ISE Sentiment Index is actually a call-put ratio.
The ISE also uses only opening long customer transactions, and eliminates market maker and firm trades.
This discards many trades that are not clear bullish or bearish bets from sentiment calculations.
For example, shorting puts is actually a bullish trade, and market makers may trade calls and puts strictly to hedge other transactions they make.
The ISE also operates on a scale of 100, with 100 representing equal demand for calls and puts.
And unlike the CBOE Equity Put-Call, the ISE is reported every 20 minutes on a slight delay.
But bizarrely, even tough the ISE Sentiment Index seems better designed, since late December, I've found the CBOE Equity Put-Call Ratio more helpful.
How You Can You Use Sentiment Indicators in Your Trading
Typically, it's better to buy when sentiment is very bearish, and it's better to sell when sentiment is very bullish.
But you must keep a few things in mind.
First, analyzing sentiment is more art than science.
Yes, we're dealing with numbers, but I can tell you from experience that trying to turn them into buy or sell signals through quantitative analysis is extraordinarily difficult.
Plus, extremes in sentiment can last quite a long time.
For example, as of April 2017, the ISE Sentiment Index has been bearish for months and months.
So don't use sentiment indicators as buy or sell signals on their own.
Just treat them as another piece of the puzzle, and incorporate them into your overall market and trend analysis.
Let's take the April 23 French election.
After analyzing the 5 sentiment indicators listed above, I determined that traders were very bearish ahead of the news.
Traders were clearly pricing in a negative outcome (namely, a victory by far-right populist Marine Le Pen).
So if I had wanted to bet on a positive outcome, I would have been encouraged by the bearish sentiment.
Because when traders are very negative, positive news can drive huge rallies, which is exactly what we saw on April 24.