Market sentiment and contrarian investing

market sentiment

It is widely recognized that trading is a zero sum game. for every winner there is a loser.

Also It is a commonly acknowledged fact that the majority of individuals in trading tend to be wrong and end up losing money, while only a small fraction of people are right and achieve significant financial gains.

So, You have to understand that when you are trading, it’s a game of supply and demand.

Example:

If you look at a stock that is widely regarded as exceptional, with numerous individuals proclaiming it as the best company and expecting its value to increase, does this inclination towards positivity suggest that the stock is more likely to rise or fall?

Why do stock price change?

We have come to understand that prices increase as a result of people purchasing assets, and through their buying actions, they drive the prices higher.

Now, when everyone is expressing positive sentiments about a particular stock, stating that it is excellent and extraordinary, it implies that they have already made their purchases of that stock.

The crucial factor to consider is not the opinions of those who have already bought the stock, but rather the interest of those who have not yet purchased it and are inclined to do so. It is this desire to buy that has the potential to drive the price upward.

Once everyone has already made their purchases and there are no potential buyers remaining, it is inevitable that those who have bought the stocks will eventually sell them, leading to selling pressure. However, what we truly care about is whether there will be buying pressure from new participants or not.

Because, if there is none, the prices aren’t going up

So, If you find yourself in a situation where everyone around you is expressing nothing but positive opinions about a particular company, urging you to buy its stock, it is likely that they have already made their purchases.

It is important to recognize that they will eventually need to sell their holdings to secure their profits, which will introduce selling pressure.

Furthermore, since everyone who could potentially push the prices higher has already established their positions, there may not be enough buying momentum remaining.

Therefore, when a unanimous consensus emerges indicating a specific direction, it often tends to result in the opposite direction taking place.

This leads us to the concepts of market sentiment and contrarian investing.

What is market sentiment?

Market sentiment refers to the overall attitude or collective psychology of market participants towards a particular financial instrument, such as stocks, currencies, or commodities.

It reflects the general mood, perception, and emotions prevailing in the market. Market sentiment can be influenced by various factors, including economic news, geopolitical events, corporate earnings reports, and investor behavior.

Positive market sentiment typically arises when investors have a favorable outlook on the market or specific assets. It can lead to increased buying activity, rising prices, and an optimistic market environment.

Conversely, negative market sentiment occurs when investors have a pessimistic view, leading to selling pressure, declining prices, and a bearish market sentiment.

Market sentiment is not solely based on objective data or fundamentals but also incorporates subjective factors such as investor confidence, expectations, and market psychology.

It can be influenced by factors like fear, greed, news events, market rumors, and the behavior of other market participants.

Traders and investors often analyze market sentiment as part of their decision-making process, as it can provide insights into potential market trends and the overall market direction.

I positioned this information after the example to emphasize the importance of understanding the meaning of market sentiment.

If you encounter a situation where market sentiment is overwhelmingly positive (e.g., 99% positive sentiment), without the context I provided, you might have been inclined to buy. However, now after the example, you are aware that when a significant majority of people have already made their purchases (e.g., 99% bought), you can anticipate what will likely occur next.

Percentages like 70% or 80% are generally acceptable, but once it surpasses 90% or 95%, that’s when things start to become more complicated.

When market sentiment exceeds 95%, it might be prudent to consider exiting your position, assuming you currently have one. Such high levels of sentiment could indicate that the stock has exhausted its momentum.

This leads us to the concept of contrarian investing.

ctrader market sentiment

Traders acquire market sentiment from diverse sources such as Reddit, Quora, investing forums, and so on.

One of them is stocktwits. here by conducting a search for the stock, you can quickly gauge whether the market sentiment surrounding it is strong or weak.

stocktwits AAPL

What is contrarian investing?

contrarian approach

Contrarian investing is an investment strategy that involves taking positions opposite to the prevailing market sentiment.

Contrarian investors believe that when the majority of market participants hold a certain view or sentiment, it may be an indication of an overbought or oversold market condition.

They actively seek opportunities to buy when the sentiment is excessively negative or sell when the sentiment is excessively positive.

Contrarian investors often take a contrarian stance based on the belief that markets tend to overreact to news and events, creating pricing discrepancies.

They aim to capitalize on these market inefficiencies by going against the crowd. By taking positions opposite to the prevailing sentiment, contrarian investors seek to profit from potential market reversals.

The underlying principle of contrarian investing is to buy when others are selling and sell when others are buying.

Contrarians focus on fundamental analysis, market indicators, and sentiment indicators to identify opportunities.

They look for stocks or assets that are undervalued or overvalued based on their analysis, and they have the conviction to go against the prevailing sentiment.

Contrarian investing requires patience, discipline, and a strong belief in one’s analysis. It is a strategy that goes against the herd mentality and aims to capture opportunities that arise when market sentiment diverges from fundamental value.

The contrarian approach is remarkably logical. It utilizes market sentiment as a tool to determine the opposing view of the general public.

Warren Buffett is a well known contrarian investor.

warren buffet quote

Conclusion

Your objective is to purchase assets prior to the majority of people and once they bought, that’s when you sell.

Market sentiment and the contrarian approach are closely tied to psychology. As you deepen your understanding of these concepts, you will gradually develop the ability to make informed and confident decisions in the financial markets.