Judging Confidence Using Sentiment Indicators

How to you judge sentiment.  There are a couple of ways to determine if market participants are exuberant or despondent. While sentiment should not be the only gauge of determining the next market move, it is a helpful way to deciding if an exchange rate will be ripe to see a change in direction.

Sentiment can be measured by performing a survey or by evaluating price. Although situation do exist where sentiment by market participants is positive but confidence by consumers and producers is negative, these measurements generally move in tandem and over the course of time will correlate highly with one another.

Consumer Sentiment

When evaluating sentiment as it relates to an economy, market participants generally focus on both consumer confidence and producer sentiment. The consumer confidence figure asks participants many question with specific responses that will gauge their enthusiasm. These questions usually focus on how they feel about a specific subject now, and their outlook for the future.  For example, do you currently have a job, and do you believe that you will have that same job or a better job in the future. Examples of consumer sentiment in the United States is the University of Michigan Consumer Confidence Survey as well as the Conference Board consumer confidence survey.

Market participants will use this information and relate it to a stock index, bond market or currency market.  Stronger sentiment is usually positive for market participants, but when sentiment rises to high, investors will look to take advantage of this euphoria and speculate that a market is too frothy.  To measure market sentiment, some investors use technical analysis tools such as the relative strength index.

Producer Sentiment

There are also many producer sentiment surveys that describe how manufacturers or service provider view current conditions or futures outlook of the business environment.  For example, in the United States, both the Institute of Supply Management along with the with consulting company Markit, producers a monthly sentiment survey where the gauge performance based on a number from 1-100.  Levels above 50 show expansion, were levels below 50 reflect contraction. Sentiment surveys are evaluated by investors, and analysts and help determine the current and future performance of an economy.

Market Sentiment

Option prices also relay sentiment. If you are considering trading market sentiment, you can use option premiums to evaluate confidence. An option is the right but not the obligation that a security will be at a specific price on or before a certain date.  When option premiums are elevated, there is fear in the air.  Most of the time elevated levels of option premiums coincide with high levels of implied volatility, which is a measure of how far a market will move.  When fear is palpable, implied volatility levels rise, reflecting fear.  Alternatively, when low levels of implied volatility are evident, market participants are complacent.  This is usually a sign of greed.  You can measure option sentiment using an index such as the VIX volatility index.

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By using a combination of consumer and producer sentiment, an investor can gauge how individuals and business view the economy. By combining these sentiment indicators with market sentiment indicators, you can evaluate if a market and economy is exuberant or fearful.