Published in the Journal of Financial Economics in 2019 by Zhenyu Gao, Jiang Luo, Haohan Ren, and Bohui Zhang, the paper examines the relationship between institutional investors and market sentiment. The authors find that institutional investors tend to sell (or buy less) risky stocks following high sentiment, and that their trades relate to sentiment corrections.
Here is a summary of the paper's findings:
* Institutional investors are more likely to sell (or buy less) risky stocks following high sentiment.
* High sentiment levels indicate that stocks are overvalued, which leads institutional investors to sell (or buy less).
* Institutional investors' trades are related to sentiment corrections.
The paper used the following sentiment indicators:
* Investors Intelligence Confidence Index: This is a monthly survey of over 1,000 individual investors that measures their confidence in the stock market.
* Ned Davis Research Bear/Bull Ratio: This is a monthly measure of the ratio of bearish to bullish sentiment among professional investors.
* AAII Sentiment Survey: This is a monthly survey of over 1,000 individual investors that measures their sentiment towards the stock market.
* CNNMoney Fear & Greed Index: This is a daily measure of investor sentiment based on a variety of factors, including stock market volatility, stock prices, and options trading.
Link to paper: https://papers.ssrn.com/sol3/papers.cfm?abstract_id=4229046
I've found sentiment to be a better indicator of bottoms than tops. The overwhelming majority of the time, indicators will trend inside a range and the best course of action 95% of the time is to do nothing. It's the extreme readings you're going to want to look for. Too many bears equals buy, too many bulls equals caution or hold.
In March 2020, I used AAII and CNN index to make two large transfers from a money market fund to a total stock index fund after three consecutive weeks of the most bearish sentiment readings in many years. There was no sense in sitting in cash with near negative interest rates at the time. Since then, those negative readings were surpassed in April and October 2022 and appear to have been good buy signals as well, though I did not act on them.
The best way to make money in stocks is invest money you can over long periods of time. You have control over the amount you're saving each paycheck, but you don't have control over which way the market is going. Keeping investment accounts in cash (TSP 100% G Fund) for extended periods of time in an effort to hopefully get in on a good buy point is not practical and I do not believe many investors do that in real life. Pension funds are obligated to have their money invested in certain ways by law or policy. Hedge funds are all about long/short trades. CNBC's buy/sell recommendations change daily.
Really, it's time in the market that matters most. Compounding works, but only in the long time frames. An investment can compound at 3% for decades before it starts to noticeably move the needle. Warren Buffet's greatest feat might just be time. He's been investing for some 70 years. Most of his holdings have just chugged along spitting out dividends for decades along the way.
Adjustments to allocation should be made to control risk. Unfortunately, the media is always pushing for a global collapse with their headlines, and investment companies push the stocks for the long run approach. Neither are good. Why be 100% invested if you've already saved "enough"? Can you afford a 20% drawdown three years before you plan on drawing down funds?
High risk portfolios are fun in bull markets but in a bear market it's, "Once I get back to even I'm going to sell," which turns into, "just a little bit more". The next downturn comes and you're looking to break even once again all because of poor risk control.
Here is a summary of the paper's findings:
* Institutional investors are more likely to sell (or buy less) risky stocks following high sentiment.
* High sentiment levels indicate that stocks are overvalued, which leads institutional investors to sell (or buy less).
* Institutional investors' trades are related to sentiment corrections.
The paper used the following sentiment indicators:
* Investors Intelligence Confidence Index: This is a monthly survey of over 1,000 individual investors that measures their confidence in the stock market.
* Ned Davis Research Bear/Bull Ratio: This is a monthly measure of the ratio of bearish to bullish sentiment among professional investors.
* AAII Sentiment Survey: This is a monthly survey of over 1,000 individual investors that measures their sentiment towards the stock market.
* CNNMoney Fear & Greed Index: This is a daily measure of investor sentiment based on a variety of factors, including stock market volatility, stock prices, and options trading.
Link to paper: https://papers.ssrn.com/sol3/papers.cfm?abstract_id=4229046
I've found sentiment to be a better indicator of bottoms than tops. The overwhelming majority of the time, indicators will trend inside a range and the best course of action 95% of the time is to do nothing. It's the extreme readings you're going to want to look for. Too many bears equals buy, too many bulls equals caution or hold.
In March 2020, I used AAII and CNN index to make two large transfers from a money market fund to a total stock index fund after three consecutive weeks of the most bearish sentiment readings in many years. There was no sense in sitting in cash with near negative interest rates at the time. Since then, those negative readings were surpassed in April and October 2022 and appear to have been good buy signals as well, though I did not act on them.
The best way to make money in stocks is invest money you can over long periods of time. You have control over the amount you're saving each paycheck, but you don't have control over which way the market is going. Keeping investment accounts in cash (TSP 100% G Fund) for extended periods of time in an effort to hopefully get in on a good buy point is not practical and I do not believe many investors do that in real life. Pension funds are obligated to have their money invested in certain ways by law or policy. Hedge funds are all about long/short trades. CNBC's buy/sell recommendations change daily.
Really, it's time in the market that matters most. Compounding works, but only in the long time frames. An investment can compound at 3% for decades before it starts to noticeably move the needle. Warren Buffet's greatest feat might just be time. He's been investing for some 70 years. Most of his holdings have just chugged along spitting out dividends for decades along the way.
Adjustments to allocation should be made to control risk. Unfortunately, the media is always pushing for a global collapse with their headlines, and investment companies push the stocks for the long run approach. Neither are good. Why be 100% invested if you've already saved "enough"? Can you afford a 20% drawdown three years before you plan on drawing down funds?
High risk portfolios are fun in bull markets but in a bear market it's, "Once I get back to even I'm going to sell," which turns into, "just a little bit more". The next downturn comes and you're looking to break even once again all because of poor risk control.
