Predicting the Direction of Stock Market Using Bull/Bear Ratio Sentiment Indicator - ToughNickel - Money
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Predicting the Direction of Stock Market Using Bull/Bear Ratio Sentiment Indicator

I have been involved in trading and in investing in stocks for four decades. I enjoy learning and writing about financial topics.

An Example of the Bull/Bear Ratio Stock Market Sentiment Indicator

The Investor Intelligence Bull/Bear Ratio stock market sentiment indicator from 1987 to the beginning of April 2019. Readings above 3 often coincided with market tops, while readings below 1 were indicating it was time to buy stocks.

The Investor Intelligence Bull/Bear Ratio stock market sentiment indicator from 1987 to the beginning of April 2019. Readings above 3 often coincided with market tops, while readings below 1 were indicating it was time to buy stocks.

Stock traders and investors utilize indicators that foretell whether the stock market is reaching a top or a bottom, so they can make informed trading decisions about whether to buy, hold, or sell stocks. While there is no foolproof method of knowing when the stock market is at an inflection point and will reverse direction, there are some indicators that can be very useful when looking for clues regarding the future direction that stocks are likely to take. One of the best indicators that can be used to predict a change in stock market direction is the bull/bear ratio sentiment indicator, which gauges how many traders and investors are currently bullish (expecting the stock market to go up) and how many are bearish (expecting the stock market to go down).

Bullish Versus Bearish Sentiment

The stock market undergoes a constant struggle between those with bullish outlooks that believe stocks will go up in price and bearish ones that are expecting stocks will go down.

The stock market undergoes a constant struggle between those with bullish outlooks that believe stocks will go up in price and bearish ones that are expecting stocks will go down.

Understanding What the Bull/Bear Sentiment Indicator Is

The bull/bear ratio sentiment indicator is used by professional traders and investors in a surprising way. Instead of taking it at face value, they use it as a contrarian measure of excessive optimism (bullishness) or pessimism (bearishness). In other words, when an overwhelming number of people think the market is going to continue moving in a particular direction, be it up or down, the pros take it as an indicator that a near-term top or bottom is forming. When there are an overwhelming amount of stock market participants that expect the stock market to remain on a bullish upward trajectory, the indicator is flashing a caution that a market top is near and sell-off may commence shortly. Conversely, when stock traders and investors are overly bearish and anticipate the stock market to continue dropping, it is an indication that a bottom may be near and is viewed as an indication that it is time to buy stocks.

Here's how Investor Intelligence determines market sentiment. The company conducts a weekly survey of over 100 widely followed and reputable investment advisors. The survey asks whether they are bullish, bearish, or neutral. The results are utilized to determine a weekly investment advisor sentiment reading. It should be noted that Investor Intelligence's survey is just one of many stock market sentiment surveys. There are others, such as the U.S. Investor Sentiment, Percentage Bull-Bear Spread, among others. They all generally operate in the same fashion and provide insight into whether bullish or bearish stock market sentiment prevails.

How to Use the Bull/Bear Sentiment Indicator to Predict Future Stock Market Moves

The bull/bear sentiment indicator is simply a ratio that indicates how many stock market participants are bullish versus how many are bearish. It works as a contrarian indicator because human psychology tends to become extreme and irrational as a stock market rises or drops. Overly-bullish feelings eventually mean participants become tapped out and don't have additional money to buy stocks because they are already fully invested. This causes the uptrend to stall and a top to form. Conversely, when the stock market is crashing and panic selling sets in, traders and investors become overly-bearish, sell stocks on impulse, and build up cash reserves. This eventually leads to a bottom, as ample cash is available on the sidelines to initiate a new rally once it becomes evident that a sell-off is overdone.

The important thing to keep in mind about the bull/bear ratio is that it is only useful to gauge stock market extremes. It is useless if you are trying to predict where the market is heading in the short-term, such as day to day or week to week. It is useful when a bull market has reached an excessive valuation or when a bear market sell-off has dropped stock market averages considerably. Under extreme circumstances, it tends to work quite well as an indicator that the stock market is nearing a change in direction.

Just keep in mind that the bull/bear ratio is just one of many stock market indicators that are worth tracking to assess whether the stock market is reaching over-bought or over-sold condition that often foretells a market top or bottom. It is most powerful when utilized in conjunction with other stock market indicators to provide a broad view of where the stock market currently is and where it is likely heading.

An Example of How the Bull Bear Sentiment Indicator Works

As can be seen in the above chart, the bottom of dips in the S&P 500 (grey line) coincide with times when bearish sentiment (red line) exceeded bullish sentiment (green line).

As can be seen in the above chart, the bottom of dips in the S&P 500 (grey line) coincide with times when bearish sentiment (red line) exceeded bullish sentiment (green line).

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This article is accurate and true to the best of the author’s knowledge. Content is for informational or entertainment purposes only and does not substitute for personal counsel or professional advice in business, financial, legal, or technical matters.

© 2019 John Coviello

Comments

John Coviello (author) from New Jersey on April 19, 2019:

It is good to know that you both found this article useful. I would stress that the bull/bear ratio sentiment indicator is only effective at predicting stock market directional turns when the sentiment is very skewed one way or another. A lot of the readings in between the extremes are just noise, which is another reason to use it in conjunction with other stock market indicators to gain a broader picture of where things are at with the stock market.

Larry Slawson from North Carolina on April 17, 2019:

I've always been interested in the stock market, but always too scared to invest haha. Thank you for sharing!

Liz Westwood from UK on April 17, 2019:

The art of predicting stock markets is a skillful one, but when successful the rewards are high.