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Sentiment Indicators

Investors/traders track a range of sentiments (consumer, investor, analyst, forecaster, management), searching for indications of the next swing of the psychological pendulum that paces financial markets. Usually, they view sentiment as a contrarian indicator for market turns (bad means good — it’s darkest before the dawn). These blog entries relate to relationships between human sentiment and the stock market.

The Predictive Power of the Put-Call Ratio for Individual Stocks

Do put-call ratios for individual stocks predicting their future returns? In their 2006 paper entitled “The Information in Option Volume for Future Stock Prices”, published in The Review of Financial Studies, Jun Pan and Allen Poteshman investigate the predictive power of put-call ratios for the returns of individual stocks. They define the put-call ratio as put buy-to-open volume divided by the sum of put and call buy-to-open volumes. Using daily volumes for all Chicago Board Options Exchange (CBOE) listed options and associated stock price data during 1990-2001, they find that: Keep Reading

Whose Sentiment Matters, and for What Horizon?

Is sentiment a useful trading indicator? In their December 2006 paper entitled “On the Predictive Power of Sentiment: Why Institutional Investors Are Worth Their Pay”, Bernhard Zwergel and Christian Klein measure the forecasting abilities of institutional and private investors and test out of sample a related trading strategy. Their source data comes from the sentix weekly sentiment survey, asking as many as 700 investors (25% institutional and 75% private investors) about the future one-month (short term) and six-month (medium term) directions of ten stock markets. Using this data for six of these markets over the period 2/23/01-2/2/06, they conclude that: Keep Reading

Buy Stocks of Companies Experts Hate?

Are the most admired companies the best investments? Or, is current state of admiration a contrarian indicator for future returns? In their February 2007 paper entitled “Stocks of Admired Companies and Despised Ones”, Deniz Anginer, Kenneth Fisher and Meir Statman test these hypotheses. The authors define state of admiration using Fortune magazine’s annual survey-based lists of “America’s Most Admired Companies.” Survey respondents are senior executives, directors and securities analysts, and the questions asked seemingly relate indirectly or directly to the investment value of the companies named. Using these lists for April 1983 (survey inception) through March 2006, associated stock return data and a separate survey of high-net worth investors, they conclude that: Keep Reading

Aggregate Investor Sentiment and Stock Returns

Is aggregate investor sentiment a useful trading indicator? For what kinds of stocks is sentiment trading most likely to work? In their December 2006 paper entitled “Investor Sentiment in the Stock Market”, Malcolm Baker and Jeffrey Wurgler summarize a top down approach to addressing these questions, focusing on the measurement of aggregate sentiment and its relationship to stock returns. They devise a long-run aggregate sentiment index derived from principal component analysis of six indicators: trading volume as measured by NYSE turnover; the dividend premium; the closed-end fund discount; the number of and first-day returns on Initial Public Offerings; and, the equity share in new issues. Using this index and stock return data for 1966-2005, they conclude that: Keep Reading

Financial News Sentiment Predicts Stock Returns?

Does exceptionally negative news coverage predict hard times for a company and its stock price? In their August 2006 paper entitled “More Than Words: Quantifying Language to Measure Firms’ Fundamentals”, Paul Tetlock, Maytal Saar-Tsechansky and Sofus Mackassy test whether they can predict a company’s future performance and stock returns by quantifying the sentiment in its financial news coverage. Their sentiment measure is a standardized level of negativity based on word counts and the Harvard psychosocial dictionary. Using Wall Street Journal (WSJ) and Dow Jones News Service (DJNS) stories about individual S&P 500 firms during 1980-2004 (350,000 significant articles), along with contemporaneous financial and stock price data, they find that: Keep Reading

Can You Learn Anything from Stock Message Boards?

Are stock message boards worth reading? If so, what clues point to useful information? In their November 2005 paper entitled “eInformation: A Clinical Study of Investor Discussion and Sentiment”, Sanjiv Das, Francisco Marti­nez-Jerez and Peter Tufano examine relationships among on-line stock message board discussions and related news and stock prices. They further employ content analysis software to measure the intensity and dispersion (level of disagreement) of message board sentiment. They focus on 170,000 messages from four stock message boards (Yahoo!, The Motley Fool, Silicon Investor and Raging Bull) for four stocks chosen to represent extremes of stock information flow (Amazon, Delta Air Lines, General Magic and Geoworks) during July 1998 through January 1999. Integrating the message board content with contemporaneous news items, stock price movements and one interview of a frequent message board poster, they conclude that: Keep Reading

Measuring Company Management Sentiment

Market mavens look at consumer, investor, analyst and forecaster sentiments. What about the sentiment of the executives of a company of interest? Does what they think about the prospects for their company matter? How can investors determine what they think? In the April 2006 version of his paper entitled “Do Stock Market Investors Understand the Risk Sentiment of Corporate Annual Reports?”, Feng Li examines the relationship between management risk sentiment and future company earnings and stock returns. Managers arguably have more freedom to express themselves in text than with numbers. Using counts of words related to risk or uncertainty in 34,180 Securities and Exchange Commission (SEC) Form 10-Ks filed between calendar years 1994 and 2005 to measure management risk sentiment, he concludes that: Keep Reading

Reading Between the Numbers

When a company reports earnings or makes presentations to analysts, should investors tune out the verbiage and focus only on the hard financial data? Or, do company executives give soft clues to future firm performance? In their January 2006 working paper entitled “Beyond the Numbers: An Analysis of Optimistic and Pessimistic Language in Earnings Press Releases”, Angela Davis, Jeremy Piger and Lisa Sedor examine the “body language” of the narratives of earnings press releases and test the response of the stock market to this qualitative information. Using textual-analysis software to measure systematically the levels of optimism and pessimism in a sample of 24,000 earnings press releases published on PR Newswire between 1998 and 2003, they find that: Keep Reading

Predicting the Past with Investor Sentiment

Jeff Walker invites visitors to the “Current Investor Sentiment” page at Lowrisk.com to express their market sentiment by predicting the direction of the Dow Jones Industrial Average (DJIA) over the next few weeks. He also generously offers weekly historical results of this ongoing poll back to May 1997. How well does this measure of investor sentiment predict the actual behavior of the DJIA? Keep Reading

Detecting Wisdom in a Crowded Market

In The Wisdom of Crowds: Why the Many Are Smarter Than the Few and How Collective Wisdom Shapes Business, Economies, Societies and Nations, James Surowiecki identifies and discusses the three conditions necessary for a crowd to make good group decisions. Applied to the stock market, good decisions means stock prices that reflect the true values of underlying assets. As depicted in the figure below, the three conditions are: Keep Reading

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