Sentiment indicators for dealing in shares

Technical analysis is not just about charts. There are hosts of other indi­cators providing additional or alternative pointers to market movements and hence tips on when to trade. Some of them work on indications of general sentiment in the market. One of the difficulties with any of these guides, of course, is that as soon as they become generally known they fail to provide reliable signals.

An example is the ‘small-lot indicator’ (small trades in shares) as a useful counter-indicator in the United States. This works on the assumption that small investors are almost invariably wrong. They buy at the top and sell at the bottom, so they provide a good counter-indicator. This has been gradually extended as it became clear it was not just the amateurs who got carried away by the prevailing or fashionable economic view: it became slightly transformed to the feeling that a universally bearish attitude in the country as a whole is a sign of an upturn and rampant bullishness is a sign to sell. Some companies even tabulate the number of investment advisers that are bullish or bearish as a sign to go the other way when unanimity seems imminent. In other words, when the small buyers start piling in it is time to sell, and vice versa. Word got around and so many people started acting on the theory that it became a self- defeating prophecy and confusion seems to have buried it.

The flow of funds indicators show demand for securities and where people are heading to put their cash. Sometimes the intensity of feeling about a company can be gauged by the volume of shares traded, espe­cially if a chart can show whether the total is up, down or unchanged. The combination of price and volume movements gives a pretty good indication of overall attitudes:

• if prices and the amounts of shares traded are both rising it is an indication that the market for the share is set to rise;
• a rising price but a declining volume of shares traded is a worrying trend indicating the price rise is running out of steam, and as the upward movement slows to a halt the direction is likely to reverse and the price will soon start to fall;
• a falling price coupled with rising volume shows investors heading for the exit in growing numbers, which can only reinforce and accelerate the falling price;
• the price and volume of shares traded both falling shows investors beginning to have second thoughts about selling and the downward pressure is therefore easing; soon it will bottom out and start upwards.

Source: Becket Michael (2014), How the Stock Market Works: A Beginner’s Guide to Investment, Kogan Page; Fifth edition.