Market sentiment is the other aspect of the larger section on market forces. However, instead of looking at more tangible entities that effect the price of a stock, sentiment is more concerned with investor attitude or perspective on a particular stock. In a purely ideal and efficient market, fundamental data and to a lesser degree technical data would be all that governs the decisions of investors. But the market is not ideal and however economists strive for it, the market is not efficient, not at least as much as it could be. So sentiment, perceptions, assumptions and general attitude towards a stock will have an impact on the price of a particular company’s share.
On a basic level there are two kinds of sentiment that govern the market and they are 1) bull market and 2) bear market. Investopedia again has a good article on what the two terms mean and how they can be better understood. On a simple level a bull market sentiment suggests a general upward movement of share price and in terms of the market, the market as a whole is getting stronger. A bear market is the exact opposite and refers to a market or a particular stock that is decreasing in value as a whole. The subject of market sentiment is still very much an unknown force, or rather a force that is difficult to mathematically explain. Thomas Dorsey in his book Point and Figure Charting, states that market direction has a “66% influence on the overall movement of an individual stock”. This being said there are many exceptions and in view of the varying forces and more significantly the importance investors place on these forces makes it very difficult to be trading on sentiment alone. It definitely exists, it definitely has a major influence for no matter how disciplined, studious on the fundamentals, etc. the market is a human creation involving human emotion and being influenced by a large number of different perceptions. For example, a company’s fundamentals might read very impressively and the share price of the company in the immediate future might confirm that this stock is only going to rise. But a piece of bad news, overall history of the company or potential wider pessimism’s about an external factor affecting the stock may keep it low for a long time. As such if you hold a stock like this, you might have to wait until other investors see the fundamentals as you saw them and change their attitude regarding the concern that is keeping this stock back. I highly encourage ‘Never trade on Sentiment alone’! There are hundreds of stocks in the market and a significant lot are following their respective fundamental news. But it can have an effect and should be taken into account.
So what more can be said? In view of the difficulty of how to gage what effect sentiment has on a company’s share price, other researches are taking place in fields such as Behavioural Finance. This assumes that markets are not efficient i.e. based purely on fundamental data and as such psychology and social sciences are better served at explaining what is going on. The area is gaining more status and in 2002, Daniel Kahneman won the Noble Prize for Economics. The main presuppositions about sentiment which behavioural finance are starting to confirm are mainly that 1) investors overemphasise the significance of fundamental data to the detriment of other equally important but more overlooked data that still can have an effect on a share’s price 2) investors take losses a lot worse than the pleasure of making a winning trade and 3) investors continue in the mistakes they make with regard to bad methodology and repeating mistakes based upon emotion. These things are obvious when you look more at the way the markets in general work and how investors interact with the market. If your pursuit like some is to understand everything, then this is a section for you to look further into. If not, like the majority of investors, it should be taken into account but do not pin all your trades upon it.
Ultimately different investors think differently about the importance of all the forces that effect a share price. It is important to know as you might have a system that is totally dependent upon fundamental company data which pays little to no attention to interest rate announcements of such like but when your stock falls in price you wonder why. It is not necessarily a bad principle if your method works most of the time but to be as objective as you can, all the forces affecting the market should be taken into account. For example long-term traders give most weight to fundamental news and justify not paying attention to technical data as technical data only plays out in the short term. Fundamentals will eventually tell in the long term future. How much sentiment will play apart in all this, only time will tell, but not everything can be explained by just looking at the figures.
Sentiment on a Macro Level
Case in point the USA recently reported in a data announcement that usa unemployment claims were back on track in one of their regular releases. Euphoria in the stock market can be infectious where Corporate America is concerned, where for no other good reason this kind of rally can spur heightened business activity. Even more so when they see all these deals going on – USAir-American deal, Berkshire-Heinz.
When you look at the underlying economy and earnings growth, things are not really much better than they were in 2012 – but that ‘feel good’ factor can’t be ignored.
Sometimes these things can be like a self-fulfilling prophecy. If people keep saying “the economy looks better”, people will feel like the economy is better, and it spreads to business managers, hiring managers and consumers. Worth being realistic and cautious about it.
Makes for a very interesting environment, I’m hoping it pays to be open-minded, the market is liable to do just about anything from here.
The UK has just been downgraded by the credit agencies In terms of the markets, the FTSE or Gilts might see some initial weakness, but we’ll still follow the US ultimately. I wouldn’t expect any fireworks after everything has had time to settle down.
That goes for the economy too, for better or worse. Any situation that the UK economy finds itself in, whether positive or negative, can almost invariably be linked to changes in conditions in the States.
We can work around the edges and give ourselves marginal advantages over other countries, but by the most part, UK politics/economics works around the periphery of what happens in the US. Give UK politicians some roadworks to oversee, a tabloid story to be “outraged” over in the Commons, or domestic issues relating to pensions, the NHS etc.
What we do over here is either ‘make the best of a bad lot’, ‘rearrange deck chairs’ or ‘marginally reform what we already have’. The success or failure of our austerity programs lie mostly in how well the US, and to an extent to the Chinese economy can grow.