Decoding Market Sentiment: Understanding Investor Trends and Volatility
In the stock market, it can be difficult to understand what type of market we are in. One of the ways investors determine the state of the market is through sentiment. Market sentiment, also known as investor sentiment, is “the current attitude of investors overall regarding a company, a sector, or the financial market as a whole,” (Smith, 2024). By gauging market sentiment, we can understand if we are in a bull (upward trending) or bear (downward trending) market and what sectors could be performing well. In this article, we will discuss the ways we gauge market sentiment and how it can be used to make well-informed decisions when investing in the stock market and the impacts they may have.
Why Does it Matter?
Gauging market sentiment is key to successful investing. Using the Fear/Greed indicator and the Volatility Index (VIX), we can investigate the health of the market and its investors to examine the long-term and short-term trends in market sentiment and understand the current state of play. Typically, investors look to invest in bullish trends as prices are generally rising across the market with more money put into equities (stocks). During bearish trends, prices generally fall, showing that many investors are looking for an exit and reallocating to safer forms of investments like bonds and money markets. Investors need to identify if the change in market sentiment is going to be short-term or long-term. During large drawdowns over an extended period of time the market sentiment can be determined to be bearish since the sellers are overpowering the buyers. During bull markets there can be spikes in negative sentiment resulting in short bearish sentiment and a drop in the value of equities. Addressing market sentiment can be pivotal to investing decisions and the long-term trend of the market.
How to Use Volatility to Scale Market Sentiment
When looking at the market, an important term to watch for is volatility. Volatility is “a statistical measure of the dispersion of returns for a given security or market index,” (Hayes, 2024). There are ranges we can observe in the VIX to help determine the current state of play. If VIX is below 15 there is lower volatility expected, indicating a calmer market. Investors will see smaller swings in their accounts during these times as price movement is more subdued across the market. When the VIX is between 15 to 20 there is a moderate amount of volatility in the market. Risk is lower but still a factor in the decisions of investors while staying moderately bullish on the trend. Volatility between 20-30 are times of heightened volatility. Risk is developing in the market, and the sentiment is growing more concerned with the current state of play. Portfolios may see larger swings up and down depending on the activity in the market that day. VIX readings of 30+ are times of extreme fear and high volatility in the market. This can be due to geopolitical events or changes in the economy. During these times there will be very large swings in prices and this could indicate an overall change in market sentiment.
Studying VIX & Market Sentiment
In recent history there have been occasions where we can analyze the relationship between market sentiment and action in volatility. 2024 had two large volatility spikes resulting in changes in the market. The first was in August, when the bank of Japan raised rates on borrowing their currency. This change triggered a carry-over trade where investors who used the Yen to buy equities closed their positions to avoid the interest that was going to be charged. This led to the VIX hitting 38.57 and the S&P ETF, SPY, dropped 6.13%. While the market rebounded the short-term trend changed to a time of more fear in the market and higher volatility. Later in December, the Federal Reserve announced a rate cut for the national interest rate of 0.25%. While the cut was expected they forecasted that 2025 could see fewer rate cuts to help deal with stickier-than-expected inflation. The market did not take kindly to this news with the VIX rising to 27.62 resulting in a 3.45% drop in the SPY.
We also saw extreme volatility during the 2020 Coronavirus Pandemic. This time, lockdowns created great uncertainty for the future, with panic spreading worldwide. On February 19th, 2020, the SPY returned 5.12% for the year before tumbling due to growing uncertainty. The market bottomed out on March 23rd, 2020, down 30.31% for the year, while the VIX hit 82.69 on March 16th, 2020. The S&P rallied for the year after this sharp drop to finish up 18.37% for 2020. This reflected a major change in market sentiment after news of stimulus payments helped spur the economy during this time.
When investing it is important to understand the waves that come in the vast ocean of the markets. There are historical studies that can be used to determine the sentiment of the market and the potential swings that may happen. In the ever-changing world of news, it is important to keep these examples in mind to work towards the long-term goal of achieving your financial goals. By monitoring market sentiment, investors can better anticipate market shifts and make informed investing decisions. Ultimately, market sentiment is a reflection of what is happening today and can be a compass of what is to come tomorrow.
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Source:
Hayes, A. (2024a, July 3). Volatility: Meaning in finance and how it works with stocks. Investopedia. https://www.investopedia.com/terms/v/volatility.asp
Smith, T. (2023a, November 14). What is market sentiment? definition, indicator types, and example. Investopedia. https://www.investopedia.com/terms/m/marketsentiment.asp#:~:text=Market%20sentiment%20refers%20to%20the,help%20investors%20measure%20market%20sentiment.