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Computerized Investing > May/June 2001

Market Sentiment

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by Wayne A. Thorp, CFA

Sentiment describes the opinions, emotions or views of a group of people. In investing, sentiment can be a powerful determinant of security prices, especially in the short run. Here, emotions—whether rational or irrational—can drive prices. For individual securities, the price is the sum total of the sentiment of all market participants. If you could forecast changes in sentiment, then you should have an advantage in determining changes in the market. The problem with sentiment is that it’s really only known after-the-fact.

Market sentiment—the summation of all market expectations—often directly reflects where the market has been, not where it is going. When market sentiment is low, this means that the majority believes the market will fall, while high market sentiment means that the majority feels the market will rise in value. However, history shows us that more times than not the market will go against the majority. Extremely bullish levels of sentiment often come after strong market run-ups when investors are fully invested in the market. Even if they are bullish about the future, they have limited additional resources to invest. By following market sentiment indicators, you may be able to pick out market tops and bottoms.

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