How to measure investor sentiment and how you can profit from this?

Closed-end funds

Individual investors are the primary owners of these funds as opposed to institutions.

Institutions such as mutual funds don't buy shares of closed-end funds or other mutual funds because their customers don't like the idea of paying two sets of fees,.

We can postulate that individual investors would be more flighty than professional investors, such as pension funds and endowments, and thus, they would be subject to shifting moods of optimism or pessimism ("investor sentiment").

When individual investors are feeling perky, discount on closed-end funds shrink and when they get depressed or scared, the discounts get bigger.


Small companies

Individual investors are also more likely than institutional investors to own shares of small companies.

Institutions shy away from the shares of small companies because these shares do not trade enough to provide liquidity a big investor needs.



How to measure individual investor sentiment?

So, if the investor sentiment of individuals varies,  it would show up both in the discounts on closed-end funds and on the relative performance of small companies versus big companies.

That is exactly what was found.  The average discount on closed-end funds was correlated with the difference in returns between small and large company stocks; the greater the discount, the larger the difference in returns between those two types of stocks.



How to profit from this investor sentiment variability?

The strategy of buying the closed-end funds with the biggest discounts earned superior returns (a strategy also advocated by Benjamin Graham).  Burton Malkiel, author of A Random Walk Down Wall Street, has also advocated such a strategy.

The Emotional Roller Coaster of the Trader

Various emotions are experienced as a trader holds onto a ticker through the various stages.

Stage 1 – Accumulation. Stock is quiet, trading sideways and without a lot of volatility. Most everyone ignores the stock because it has no sizzle. Insiders hold large blocks of stock and quietly gear up for the distribution.

Stage 2 – Breakout. Volume jumps up, psychological barriers are broken. Insiders begin to tell their friends of upcoming significant fundamental change. Pros take notice and buy the stock on the coat tails of the well informed. The public ignores it because they have not read about the company in the paper yet. It must be a scam.

Stage 3 – Uptrend. As a larger audience learns of the company and its promise, more buying comes in to the stock and it begins to climb. Pros begin to sell, but slowly. Average investor begins to buy.

Stage 4 – Pullback. The stock has gone up too fast, and some profit taking arrives. The jumpy investor who got the entry timing right but lacks confidence in his or her decision sells the stock with a small profit, and smiles in the mirror. The Pro holds on, Average Investor looks through the newspaper to find justification for ownership of the shares.

Stage 5 – Resumption of the Uptrend. The pull back is short lived, and the stock bounces and continues higher. The wannabe regrets the sell, but provides self counsel on the merit of making a profit, albeit a small one. The Pro might sell a little bit more, but still holds the majority of the original position. The Average Investor is getting excited now, and thinks about what could have been if only he had bought when he first noticed the stock.

Stage 6 – Exhaustion of the Uptrend. The media takes notice, and communicates the company’s merits to the masses. The masses buy the stock, and it goes up sharply with strong volume. The Pros sell with enthusiasm. The Average Investor owns it now, and is telling everyone who will listen. The wannabe Pro jumps back on, after all, he was smart enough to buy it when the trend started, so he knows the stock well. Will hope make it go higher?

Stage 7 – Gravity Works. Pro selling begins to weigh on the uptrend, and the stock fails to go higher despite high volumes. The stock starts to go down instead of up, and the Pro is almost sold out. The Average Investor continues to cheer lead, hoping to rally support. The wannabe ignores what the market is telling him, taking a loss is too painful to consider. The company is featured on the cover of a magazine.

Stage 8 – The Second Guess. The stock bounces and starts to go back up. The wannabe Pro averages down while the Average Investor gets back to advising friends of his stock picking acumen. Pros sell their remaining holdings and begin to look for another deal to play, or perhaps start short selling the stock.

Stage 9 – Out of Gas. The bounce is a fake out, and the stock moves lower again. The public own this stock, and they have no more power to buy. The Pro are making money on the short sales now, but are despised by the masses. Calls for short selling to be made illegal are made by the Average Investor, after all, the short sellers are the demons causing the sell off.

Stage 10 – Dead Cat Bounce. The Average Investor and the wannabe Pro have no pain tolerance left, and finally sell for a big loss. The short selling Pros are the only buyers to take the share off their hands, and provide the needed liquidity. The stock bounces, and some short term traders make a quick profit. The Average Investor either swears to never buy a stock again, or tells lively stories over drinks about the one that could have been.

Stage 11 – Post Mortem. Pros have forgot about the stock and are considering carpet samples for their new home in Florida. Average Investor continues to follow the company and buys loads of cheap stock to try and overcome the regrettable loss.

The stock market is mean. You can be a good analyst, but if you can’t overcome the psychological traps of trading, you will do what the crowd does. To be successful, you have be one step ahead of the crowd, and trade with unemotional discipline. There are strategies to take advantage of each stage of the marketcycle that can be applied just by looking at a stock chart. They just require a bit of knowledge.


https://toohightoolo.wordpress.com/tag/lifecycle/

Points of Maximum Financial Risk and Financial Opportunity

 

When Stock Prices Drop, Where's the Money?

To sum it all up, you can think of the stock market as a huge vehicle for wealth creation and destruction.

When Stock Prices Drop, Where's the Money?

by Investopedia Staff
Monday, March 16, 2009

Have you ever wondered what happened to your socks when you put them into the dryer and then never saw them again? It's an unexplained mystery that may never have an answer. Many people feel the same way when they suddenly find that their brokerage account balance has taken a nosedive. So, where did that money go? Fortunately, money that is gained or lost on a stock doesn't just disappear. Read to find out what happens to it and what causes it.

Disappearing Money

Before we get to how money disappears, it is important to understand that regardless of whether the market is in bull (appreciating) or bear (depreciating) mode, supply and demand drive the price of stocks, and fluctuations in stock prices determine whether you make money or lose it.

So, if you purchase a stock for $10 and then sell it for only $5, you will (obviously) lose $5. It may feel like that money must go to someone else, but that isn't exactly true. It doesn't go to the person who buys the stock from you. The company that issued the stock doesn't get it either. The brokerage is also left empty-handed, as you only paid it to make the transaction on your behalf. So the question remains: where did the money go?

Implicit and Explicit Value

The most straightforward answer to this question is that it actually disappeared into thin air, along with the decrease in demand for the stock, or, more specifically, the decrease in investors' favorable perception of it.

But this capacity of money to dissolve into the unknown demonstrates the complex and somewhat contradictory nature of money. Yes, money is a teaser - at once intangible, flirting with our dreams and fantasies, and concrete, the thing with which we obtain our daily bread. More precisely, this duplicity of money represents the two parts that make up a stock's market value: the implicit and explicit value.

On the one hand, money can be created or dissolved with the change in a stock's implicit value, which is determined by the personal perceptions and research of investors and analysts. For example, a pharmaceutical company with the rights to the patent for the cure for cancer may have a much higher implicit value than that of a corner store.

Depending on investors' perceptions and expectations for the stock, implicit value is based on revenues and earnings forecasts. If the implicit value undergoes a change - which, really, is generated by abstract things like faith and emotion - the stock price follows. A decrease in implicit value, for instance, leaves the owners of the stock with a loss because their asset is now worth less than its original price. Again, no one else necessarily received the money; it has been lost to investors' perceptions.

Now that we've covered the somewhat "unreal" characteristic of money, we cannot ignore how money also represents explicit value, which is the concrete worth of a company. Referred to as the accounting value (or sometimes book value), the explicit value is calculated by adding up all assets and subtracting liabilities. So, this represents the amount of money that would be left over if a company were to sell all of its assets at fair market value and then pay off all of liabilities.

But you see, without explicit value, implicit value would not exist: investors' interpretation of how well a company will make use of its explicit value is the force behind implicit value.

Disappearing Trick Revealed

For instance, in February 2009, Cisco Systems Inc. had 5.81 billion shares outstanding, which means that if the value of the shares dropped by $1, it would be the equivalent to losing more than $5.81 billion in (implicit) value. Because CSCO has many billions of dollars in concrete assets, we know that the change occurs not in explicit value, so the idea of money disappearing into thin air ironically becomes much more tangible. In essence, what's happening is that investors, analysts and market professionals are declaring that their projections for the company have narrowed. Investors are therefore not willing to pay as much for the stock as they were before.

So, faith and expectations can translate into cold hard cash, but only because of something very real: the capacity of a company to create something, whether it is a product people can use or a service people need. The better a company is at creating something, the higher the company's earnings will be and the more faith investors will have in the company.

In a bull market, there is an overall positive perception of the market's ability to keep producing and creating. Because this perception would not exist were it not for some evidence that something is being or will be created, everyone in a bull market can be making money. Of course, the exact opposite can happen in a bear market.

To sum it all up, you can think of the stock market as a huge vehicle for wealth creation and destruction.

Disappearing Socks

No one really knows why socks go into the dryer and never come out, but next time you're wondering where that stock price came from or went to, at least you can chalk it up to market perception.


http://finance.yahoo.com/focus-retirement/article/106739/When-Stock-Prices-Drop-Where

For traders: Always keep in mind that the company and its stocks are distinct

A company may reach new heights of prosperity while you as individual stockholder own a bit of it, but you still can lose money.  Why?  You and other temporary owners have bought merely rights to cash in on whatever changing level of perception other people (taken as a whole, the market) may hold about that company.

1.  They may like it less tomorrow

• because of buying in too late (too high), 
• because interest rates are rising (making all equities less attractive relative to bonds or Treasury bills); 
• because of adverse public opinion about its products or industry;
• because of press publicity over high executive salaries; 
• because general corporate reputation might deteriorate; 
• because investment tastes shift in favour of other industries; or 
• because of a rising fear of recession.

2.  Or the overall stock market may be declining from a too-high prior level.

3.  Other investors collectively may be right or wrong about the company over the short to medium term.  And you as an individual may prove correct, while the majority are incorrect, about fundamentals.


To determine whether now is the time to hold or to sell, focus on changes in perception rather than on long term fundamentals.  An investor can be dead-on right about fundamentals, but if the market collectively decides that it no longer is willing to pay as much for this company's reputation or earnings, its share price heads south.  Eventually, an individual's logic may be vindicated again as value reasserts itself and other investors resume their willingness to pay for it.  But in that interim, the individual is going to suffer a loss for fighting the tape.

As Benjamin Graham noted in The Intelligent Investor, markets act as voting machines in the short term but in the long run function as weighing machines.  Thus, actions and opinions of the crowd determine share price in the short to medium term, which is the most important factor because that share price determines whether you have a gain or a loss, and when.  So buy and sell not just on personal judgment of a company behind a stock but on your studied assessment of what other investors think of the company and how that thinking seems to change.  A great company can be a bad stock (for trading or investing) if bought at just any price without regard to reasonable value.

Prices on the tape reflect people's reactions and perceptions and beliefs translated into buying and selling decisions; they do not reflect the truth about a company's fundamentals.  So keep in mind that the company and its stock are distinct.  

Being able to keep a company and its stock strictly separate in your mind has become ever more critical in recent years.  Excellent companies may suffer single-quarter earnings shortfalls against analyst estimates or might even experience actual interim declines in earnings.  Such minor stumbles usually call down immediate and massive institutional selling.  While such selling may be vastly disproportionate to any long-term true fundamental meaning of the triggering event, it does signal a coming period of more cautious appraisal by major investors.

If you maintain the mental agility to view a stock as merely an opinion barometer because you have separated it from the company's fundamentals, you will be able to sell without costly hesitation.  Fail to differentiate a company and its stock in your mind and you will have great difficulty over separation and loyalty issues and will be less successful in your investment moves.  Unless you plan on holding forever, which will produce merely average or even sub-par returns, you need to buy and sell.

Swings in market psychology drive prices to fluctuate around true long-term value (if only the latter could ever be known accurately today!).  Another way of viewing these price swings is to think of them as changes in the consensus of esteem given to a company by all investors taken together.  When esteem runs up above reasonable valuation of fundamentals, price will eventually correct downward to redress that temporary mistake.  Above-average profits accrue to those who capture such positive differentials of esteem minus reality.  (Similarly, on the buying side of the equation, handsome profit opportunities can be captured when reality minus esteem is a positive number, meaning that the stock in more common terms is temporarily undervalued by the market of opinion.)

Sentiment Curve

Market Sentiment Curve

The Sentiment Curve of Investing

Singapore retail investors back as volume surges

Retail investors appear to have returned to Singapore market, judging from today’s robust trading volume, says Dow Jones.

More than 2.76 billion shares changed hands so far vs 1.59 billion for whole of yesterday, clearing 2 billion mark for first time since February. Activity driven mostly by penny stocks, led by GMG Global (5IM.SG), Advanced Systems Automation(520.SG), United Fiber System (P30.SG).

While STI +8.2% since beginning March, run-up so far not accompanied by substantial volume. Still, value of all shares currently traded on SGX not much higher than yesterday’s $1.17 billion, last at $1.52 billion, as penny shares main volume driver.

Whether coming sessions can attract equally robust volume remains to be seen, especially with investors expected to be watchful when Singapore earnings season begins next week. STI +0.5% at 2,990.59.

http://www.theedgesingapore.com/the-daily-edge/business/14190-singapore-retail-investors-back-as-volume-surges.html

How does investor psychology affect timing?

Investors are inclined to become over-enthusiastic during a bullish phase on the stock market and to become despondent when the market declines.

In order to be a successful investor, it is important to distance yourself from the herd mentality and to take objective decisions based on fundamental reasons.

The typical behaviour of investors is linked to the so-called psychological cycle of investors (Source:  Adapted from Geld-Rapport, 18 March 2001).

Contempt: According to the cycle, a bull market typically starts when a market is at a low and investors scorn stocks.

Doubt and suspicion: They try to decide whether what they have left should be invested in a safe haven, such as a money market fund. They've burnt their fingers on stocks, and vow never to invest again.

Caution: The market then gradually starts showing signs of recovery. Most remain cautious, but prudent investors are already drooling at the possibility of profit.  Now is the best time to buy shares.

Confidence: As stock prices rise, investors’ feeling of mistrust changes to confidence and ultimately to enthusiasm. Most investors start buying stocks at this stage.

Enthusiasm: During the enthusiasm stage, prudent investors are already starting to take profits and get out of the stock market, because they realize that the bull market is coming to an end.

Greed and conviction: Investors’ enthusiasm is followed by greed - often accompanied by numerous new listings or IPOs on the stock market.

Indifference: Investors look beyond unsustainably high price-earnings ratios.

Dismissal: As the market declines, investors show a lack or interest that quickly turns to dismissal.

Denial: They then reach the denial stage, where they regularly affirm their belief that the market definitely cannot fall any further.

Fear, panic and contempt: Concern starts to take hold; fear, panic and despair soon follow. Investors again start scorning the market. Once again, they vow never to invest in stocks again.

http://www.minyanville.com/articles/markets-cycles-psychology-bull-bear-panic/index/a/18736

Also Read:

Sentiment curves
http://myinvestingnotes.blogspot.com/2009/05/sentiment-curves.html

Flip-flopping from gloom and doom back to boom... this is fun!

Watch all the media types get whiplash flip-flopping from gloom and doom back to boom - wheeeee, this is fun!

http://seekingalpha.com/article/185412-thank-gdp-it-s-friday?source=article_sb_picks

Sentiment curves

How To Interpret What Your Dealers & Remisers Are Saying








An "expert" used to say " market looks like will go up but fear it will correct".

Ref: http://malaysiafinance.blogspot.com/2009/04/how-to-interpret-what-your-dealers.html




Other sentiment curves








Also click:
Capitulation - the point when everybody gives up.

Capitulation - the point when everybody gives up.

Sunday, 12 Oct 2008
Identifying Capitulation: How to Tell We've Hit Bottom

Posted By:Daryl Guppy

Are we there yet? This is the key question and it relates to finding the bottom of the market.

In many ways it's a pointless question. Even if we could identify the turning point in the market with a high level of certainty, there are very few people with the courage to enter at these low points.

The more important thing to look for are the features that will help to identify, first, the end of the market fall and second, the development of a market recovery. These two events may be separated by a few months, or by many months.

There are two important features that identify climax selling. The first is the rapid acceleration in the speed of the market fall. Like a Stuka dive-bomber, the market first rolls over slowly and then plunges in a vertical dive. This is fear at work.

The second feature is a massive increase in volume. This is panic. Ordinary people are desperate to get out of the market. Generally the funds and institutions got out of the long-side of the market many months ago. The selling in January and February was dominated by institutions and funds. The current panic selling is thousands of small orders from retail investors desperate to get out of the market.

During the bear market collapse, volumes decline. Fewer people want to buy stock so volatility increases because small trades have a disproportionate impact in a shallow market.

This selling climax shakes out all the weak hands in the market. It kills the margin speculators. It wipes out those who have finally lost patience. It removes the speculative money in the market because people think the risk is too great. This is also called capitulation. Everybody gives up – and it influences the thinking of a generation. My parents, who lived through the depression, could never entirely shake the idea that the market was a dangerous place.

The activity in the Dow Jones Industrial Average and other global markets shows an acceleration of downwards momentum. The massive increase in volume has not yet developed and this suggests the market bottom is not yet established. There is a high probability that markets will see a selling climax in the next 3 to 5 days. But here is the important difference.

The recovery rally after climax selling is temporary. It is part of a longer-term consolidation pattern that may last months, or even a year, and make more new lows before a new sustainable uptrend can develop. The potential shape of the recovery is shown in the chart. The bull market rebound rally follows a temporary selloff. A bear market rebound rally follows climax selling. It is a relief really, but it is not part of a sustainable trend change.

After a bear market, volumes remain low. When you lose trillions of dollars it takes a long time for spare change to start rattling around the economy again. Spare change drives the bull market because money is available for speculation.

In the immediate bear market recovery period the market is dominated by professionals. Finance industry professionals are already being laid off. The least effective are the first to be let go. Only the best will survive the employment washout in the industry and these will be the ones defining the behavior of the consolidation and recovery market.

When you trade in these market conditions you are most likely trading against these professional survivors. Education, not money, is the most important premium after the bear market.

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