The SPX (S&P 500 Index) has been on a very wild ride lately. When most were expecting the rally in early September to go on forever, sentiment was telling a different story. As a matter of fact, it was suggesting to get short, as investor sentiment was at extreme bullish readings, which we noted in this TraderPlanet article.
Using Sentiment
When using sentiment as a gauge to make a trade, it is best used as a contrarian indicator. An example would be, if too many traders are bullish on the direction of a stock or index, you want to start using some of your technical skills to find out where a possible turn lower would hit.
There is an old saying – “When too many people jump on one side of the boat, the boat will tip.” The same holds true for trading, when too many traders become too bullish or bearish at the same time, the trend is almost certain to change.
In early September, after the SPX rallied sharply off the lows in August and was making new all-time highs, investor sentiment was hitting extreme bullish readings. This would imply a reversal to the downside. That is exactly what happened, and we saw the SPX drop some 200 points off the highs.
When we were at the lows in October, however, investor sentiment switched to overly bearish. This would imply a trend reversal to the upside. That is exactly what we have seen again, as the SPX has rallied some 140 points since the sentiment bearish extremes.
Currently, sentiment is swinging back to extreme bullish sentiment, which would suggest we should see some type of set back and a reversal to the downside to hit soon.
We should monitor the technical readings to see where a reversal might occur. My target has been 1960-1965 from the lows, and that was the high so far.
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