# What Is Market Sentiment? Definition, Indicator Types, and Example

> **Definition**
>
> Market sentiment reflects investors' attitudes toward stocks, industries, or the financial market as a whole. Influenced by crowd psychology, it surfaces in trading behaviors. Bullish sentiment signals rising prices, while bearish sentiment indicates declining prices. This concept is crucial for day traders, technical analysts, and contrarian investors who leverage short-term price movements, unaffected by fundamental market changes.

Market sentiment is how investors generally feel about a company, sector, or the entire financial market. Crowd psychology affects the market mood, which is shown through buying and selling actions.

In broad terms, rising prices reveal bullish market sentiment, while falling prices indicate bearish market sentiment.

### Key Takeaways

*   Market sentiment reflects the current mood of investors and can influence buying and selling activity in the financial markets.  
    
*   Indicators such as the VIX, high-low index, and moving averages help investors gauge market sentiment and make informed trading decisions.  
    
*   Bullish market sentiment is associated with rising prices, while bearish sentiment corresponds to falling prices.  
    
*   Emotional responses, rather than fundamental analysis, often drive market sentiment, leading to potential volatility.  
    
*   Social media platforms can significantly influence market sentiment by amplifying the opinions and emotions of traders and investors.

## How Market Sentiment Affects Investor Behavior

Market sentiment, sometimes called investor sentiment, does not correlate to fundamental changes in the market. Day traders and technical analysts rely on measurements of market sentiment since it influences the indicators used to measure and profit from short-term price moves caused by the crowd psychology of active investors.

Market sentiment is also important for contrarian investors who trade in the opposite direction of the prevailing consensus. For example, if everyone is buying a stock, a [contrarian](https://www.investopedia.com/terms/c/contrarian.asp) would sell it in order to profit from the move upwards.

Market sentiment is often described as either bearish or bullish. When sentiment is bearish, prices drop. When it's bullish, prices rise.

Emotion often influences the stock market, so market sentiment may not align with a stock's fundamental value. Changes in prices occur for many reasons beyond what a fundamental analysis would deduce.

Market sentiment demonstrates broad concerns, expectations, and emotions about the market, while fundamental value is about real business performance.  

## Key Market Sentiment Indicators Explained

Many investors profit by buying stocks misvalued because of market sentiment.  They use several indicators to measure market sentiment to help them determine the best stocks to trade, including the CBOE Volatility Index [(VIX)](https://www.investopedia.com/terms/v/vix.asp), the high-low index, the bullish percent index (BPI), and moving averages.

### Understanding the VIX: The Fear Index

The VIX, also known as the fear index, is driven by [option prices](https://www.investopedia.com/ask/answers/062415/how-does-implied-volatility-impact-pricing-options.asp). A crucial tool for traders, the VIX indicates the expected volatility of the S&P 500 index.

High VIX levels can signal heightened worries, potentially a signal of a market bottom. A low VIX can suggest market complacency and is seen as a clue that a market may have peaked.

### How the High-Low Index Reveals Market Mood

The high-low index compares the number of stocks that have reached [52-week highs](https://www.investopedia.com/terms/1/52weekhighlow.asp) to the number of stocks that are at 52-week lows.

When the index is below 30, stock prices are trading near their lows, and investors have a bearish market sentiment. When the index is above 70, stock prices are trading near their highs, and investors are bullish.

Traders often use this indicator on specific indexes, like the S&P 500 or Nasdaq 100.

### Decoding the Bullish Percent Index for Market Trends

Based on point and figure charts, the BPI measures the number of stocks with bullish patterns.

Neutral markets have a bullish percentage of about 50%. When the BPI reads 70% or higher, market sentiment is extremely optimistic, which could signal that stocks are overpriced.

When it measures 30% or below, market sentiment is negative, indicating an oversold market.

### Interpreting Moving Averages in Market Sentiment Analysis

Investors typically use the 50-day moving average (MA) and 200-day MA when determining a market’s sentiment.

When the 50-day MA crosses the 200-day MA from below it is called the “[golden cross](https://www.investopedia.com/terms/g/goldencross.asp)." This indicates that momentum has shifted to the upside, creating bullish sentiment.

When the 50-day MA crosses below the 200-day MA, this is called the “[death cross](https://www.investopedia.com/terms/d/deathcross.asp)." It suggests lower prices and bearish sentiment.

## Limitations of Relying on Market Sentiment Alone

Though a handy tool in financial markets, market sentiment has limitations. The herd mentality is swayed most easily by fear and greed. It is not necessarily a reaction to the fundamentals of a stock or a market.

Moreover, short-term news, events, worries, and even rumors can sway market sentiment, especially in fast-paced, high-liquidity markets. When everyone's riding a wave of optimism, it might mean a peak is coming, and the opposite is true when investors are in a doom-and-gloom mood. As a result, irrational market sentiment can lead to greater market volatility.

Remember that the data on sentiment can be a bit of a wild card. Surveys, social media, and news reactions can be all over the map. This makes it hard to determine if the underlying information is misleading or incorrect.

It's important to keep in mind that market sentiment is like a sprinter in short-term trading but not much of a marathon runner. If you're in it for the long haul, it's more productive to think about the big picture and diversify your portfolio.

## Illustrative Examples of Market Sentiment in Action

An uncertain economic outlook often leads to wild swings in the stock market between bullish and bearish sentiments. We can use an example from the early 2020s. As you can see in the chart below, fear picked up among equity investors at various points throughout 2022, leading to intraday volatility in the S&P 500 not seen since the Great Recession of 2008.

High inflation and the response of central banks were likely to blame. In the traditional [economic cycle](https://www.investopedia.com/terms/e/economic-cycle.asp), when interest rates start rising significantly, it’s only a matter of time before the impact of higher borrowing costs causes a recession.

![VIX vs. S&P 500](https://www.investopedia.com/thmb/t3WZRaZuZPmqT9z52QK4z_JCYuw=/1500x0/filters:no_upscale():max_bytes(150000):strip_icc()/CBOEvsSP-44dca37cdbed46f2829bd36992bca527.JPG)

*VIX vs. S&P 500.*

Many investors grew alarmed that the economy was about to crash and started selling. However, a handful of others sought to capitalize on these jitters, thinking a recession would be averted. Gradually, the economic doom and gloom subsided.

### Analyzing Market Sentiment Trends in 2023

In 2023, economists grew increasingly confident that the year would not end in recession despite earlier worries. Market participants, keen to profit from equity markets priced to reflect an economic meltdown, quickly turned bullish. The S&P 500 began its ascent again, and the VIX gradually dropped.

By September 2023, the VIX showed that volatility hit a three-year low, suggesting calmness among investors. 

Economic sentiment will shift again at some point. Over time, as economic conditions evolve, analysts and investors adjust their outlooks. When the market prices in extreme scenarios, like a meltdown, sentiment can turn bullish with positive data. 

Market sentiment is sensitive and can change quickly. After a period of optimism, when valuation multiples reflect a positive outlook, the market becomes vulnerable. Even minor negative news can shift the mood, turning bullish investors bearish again.

## How Does Social Media Influence Market Sentiment?

Social media has become a significant factor in shaping market sentiment. Platforms like Reddit can amplify market sentiment and the opinions of a few contrarians, often leading to rapid, sentiment-driven moves in stock prices. For instance, a trending hashtag or a viral post about a company can quickly sway public perception, impacting its stock performance.

## Are There Sectors That Are More Sensitive to Market Sentiment Than Others?

Yes, some sectors are more sensitive to changes in market sentiment. Technology and consumer discretionary stocks have wide appeal to individual investors and generate far more chat, positive and negative.

Utilities and consumer staples are more stable for many reasons. They attract less attention and create less noise on the internet.

## Can I Use Market Sentiment Indicators To Predict Stock Market Crashes?

Market sentiment indicators like the VIX can help decipher the mood and expectations of investors, but they are not foolproof for predicting market crashes. These indicators reflect current or short-term expectations of volatility but cannot account for unforeseen events or long-term economic trends.

## The Bottom Line

Market sentiment, reflecting crowd psychology, is a critical tool for understanding investor behavior in the market. It can be bullish, indicating rising prices, or bearish, suggesting prices are falling. Regardless of sentiment, it's important for investors to recognize that emotions often drive market movements, not fundamental values. While short-term sentiment can cause volatility, long-term investors should focus on the bigger picture and maintain a diversified portfolio to navigate shifts in sentiment effectively. This approach allows investors to remain resilient regardless of whether the mood leans towards optimism or pessimism.

> **Article Sources**
>
> 1.  Corporate Finance Institute. "[Overview, Examples, Contrarian Investing Strategies](https://corporatefinanceinstitute.com/resources/career-map/sell-side/capital-markets/contrarian-investing/)."
>     
> 2.  C. Bai et al. "[Financial Market Sentiment and Stock Return During the COVID-19 Pandemic.](https://www.sciencedirect.com/science/article/pii/S1544612323000831)" _Finance Research Letters_ (June 2023).
>     
> 3.  CNN. "[Fear & Greed Index](https://www.cnn.com/markets/fear-and-greed)."
>     
> 4.  CBOE. "[CBOE VIX Index](https://www.cboe.com/tradable_products/vix/)."
>     
> 5.   StockCharts. "[High-Low Index](https://school.stockcharts.com/doku.php?id=market_indicators:high_low_index)."
>     
> 6.  StockCharts. "[Bullish Percent Index](https://school.stockcharts.com/doku.php?id=market_indicators:bullish_percent_index)."
>     
> 7.  A. Rishad. "[An Empirical Examination of Investor Sentiment and Stock Market Volatility: Evidence From India](https://jfin-swufe.springeropen.com/articles/10.1186/s40854-020-00198-x)." _Financial Innovation_. 6/34 (2020).