I was always interested in market sentiment, but I typically used anecdotal comments or polled sentiment surveys (II, AAII, etc.) until late in 1996 when the VIX and CBOE Put/Call ratios became available to retail traders on a timely daily basis. I looked at both data series, and it occurred to me that a combination of the two made sense. I imagined in my devious sentiment mind that "they" could fool us some days with one measure and some days with the other; so if I combined them I got a better "fingerprint" of current market sentiment as reflected only in what people actually were doing rather than in what they were saying to pollsters.
Other people must surely have thought of this same very simple indicator and kept their mouths shut. I started doing a daily multiple or product of the CBOE combined P/C Ratio times the VIX (now VXO). I called it the 2CS, and I have tabulated it daily since mid 1996. To smooth it a bit, but still keep it close to daily action, I decided early on to use a five day running total of each day's product of VXO times P/C. There is no hidden or proprietary stuff here. I've written a lot about it at this blog and elsewhere.
Sentiment dogma states that the great majority of all investors and speculators is always wrong. And that's a safe bet most of the time. The majority gets most bullish at tops and most bearish at bottoms. And that's true for short and intermediate term high and low swings within a longer term trend. But I learned later on that toward the ends of longer term trends, some part of the majority "gets it right" and sees ahead. So at extreme highs and lows we often get what I call "sentiment divergence" or "range shifting".
2CS range shifting is something I had begun to worry about since last summer (2007). We made new highs several times into October, but the 2CS (with VXO and P/C ratios inverted) didn't make new lows as compared to February 2007.
The 2/20/07 2CS was 44.46 (SPX close 1459.7). 7/9/07 2CS 63.06 (SPX close 1531.85). 10/09/07 2CS 63.11 (SPX close 1565.15). Price was making new highs, but bullishness was lagging and making new lows at those price highs. When we start to see this counter-intuitive divergence or price and bullisness, I believe that we have to consider that the longer term trend is in the process of changing.
At the other end of the price and sentiment range we suddenly got a very great increase in bearishness at the market low in August 2007 when 2CS ran higher than at the 2003 market low! I commented on it here and elsewhere, but I don't want to pretend that I totally understood the implications of it myself immediately or communicated them crisply ....at least consciously.
However, all year in 2007 I was feeling increasingly nervous that I was going to lose a lot of money if I didn't cut back on stocks. I was doing the 2CS and seeing those numbers, and my gut was understanding them. But i wasn't verbalizing or accepting it at a rational level. But I did cut back anyway, and drastically all year, although I felt like a "wimp" while doing it. I tend to be optimistic, and I like to be bullish. This may be a fault, but it's what I am.
Whether this makes any sense to other investors I can't say. I couldn't accept or communicate my market feelings, BUT I was acting on them. And it has saved me a bundle so far this year. I told all this to my wife the other day, and she said there's hope for me after all. :) Women know all this stuff.
I'll post a chart of 2CS another time. See if you can follow the argument first.
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