Psychological Market Indicators

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Investor’s Business Daily offers a full suite of premium products designed to help the do-it-yourself investor make wise investments, and one of those products is IBD Digital, which contains many features and individual tools. One tool I found to be especially interesting while trying out IBD Digital is their proprietary Psychological Market Indicators.

IBD Digital’s Psychological Market Indicators

IBD’s Psychological Market Indicators are actually inside Market Trend, a secondary umbrella feature under IBD Digital. The main Market Trend feature offers a basic summary of what’s going on in the markets on that particular day, and IBD’s Psychological Market Indicators takes things a step further by reading sentiment into what’s happening.

IBD offers five main proprietary indicators: CBOE Market Volatility S&P 500, Put Call Ratio, High-Low Ratio, Bulls vs. Bears, and Margin Debt. The platform defines each of these proprietary indicators and then displays a chart that’s updated continually to help investors understand what the rest of the market might be thinking about a particular event.

Each of IBD’s Psychological Market Indicators offers insight that seems catered to investors with a short-term mindset, such as day traders. They can all be quite helpful for those looking to tap into major market movements that are driven by knee-jerk reactions to various events.

CBOE Market Volatility S&P 500

The first psychological indicator on the list is the CBOE Market Volatility S&P 500 indicator, which IBD describes as “a technical sentiment indicator that helps determine major market bottoms as well as shorter-term swings.” This indicator is designed to predict volatility levels using option prices for the S&P 500.

The daily volatility index, also known as the VIX, enables investors and traders to predict market bottoms in the short to intermediate term. Volatility rises along with fear in the stock market, and that’s usually when major indices such as the S&P 500 hit bottom before rallying. Volatility has been so low for so long that when the U.S. stock market got a taste of it during the first quarter, the market reaction was quite extreme, with many investors heading for the hills, albeit temporarily.

IBD advises investors who are looking at its CBOE Market Volatility indicator that a positive market reversal is confirmed when the VIX rises more than 20% over its 10-day moving average. The chart included in this proprietary indicator is very thorough, although at first glance, it is a little confusing. Left-clicking on the chart brings up the date, the day’s high and low levels of the VIX, the 10- and 50-day moving average, and the S&P 500.

However, the most important readings it brings up are the percentage differences in the VIX between the high and low levels. This makes it very easy for users to see whether or not a positive reversal has been confirmed. For example, this indicator showed that the VIX was 2.4% below the 10-day moving average, so it’s nowhere close to indicating a positive reversal.

Put Call Ratio

The second of IBD’s Psychological Market Indicators is the Put Call ratio, which the site describes as “a contrarian sentiment indicator that helps determine major and short-term market bottoms.” This indicator provides a comparison between the number of puts and calls that are traded every day.

A reading higher than 1 indicators that the options market has turned bearish and is favoring puts over calls, but a reading higher than 1.15 confirms a positive reversal in the S&P 500 or NASDAQ or a follow-through day, which confirms that a rally is holding steady rather than just a temporary upward tick.

High-Low Ratio

IBD’s High-Low Ratio is described as a “technical indicator that can flag rebounds from intermediate corrections during bull markets.” It gauges the ratio of new highs versus new lows, and the key is to look for a 0.5 reading. Users must look for the first day the indicator moves up after falling under 0.5, which IBD states indicates “a short-term bottom in an intermediate correction during a bull market.”

This indicator doesn’t really help very much during bear markets when both the S&P 500 and the NASDAQ are under their respective 200-day moving averages. However, we’ve been in a bull market for so long that it could be somewhat helpful.

Bulls vs. Bears

IBD describes its proprietary Bulls vs. Bears indicator as “a contrarian sentiment indicator that confirms market bottoms.” This indicator comes from the Investors Intelligence survey, which is conducted weekly with writers of the newsletter. IBD states that whenever the bears are winning on this indicator, it’s likely that the market is close to a bottom.

The chart that’s included with this indicator plots the S&P 500 against the bull and bear readings over a week. At the time I looked at it, the bulls were dominating it with 43.1%, while the bears had only 20.6%. Of all of IBD’s Psychological Market Indicators, I felt like this one was the least helpful because it’s based purely on how newsletter writers feel about the market, making it feel rather like reading yet another analyst report.

Margin Debt

The last of IBD’s proprietary Psychological Market Indicators is Margin Debt, which the site describes as “a contrarian sentiment indicator that has flagged three major market tops since the 1970s. IBD states that investors can expect a major top in a bull market by looking at the year-over-year changes in margin debt. It passes 55% while investors are especially optimistic and borrowing money like mad during a bull market’s late stages. This indicator will likely become more and more important in the near term because the current bull market has been going on for so long.

The indicator read only 11.7% when I looked at it, which is interesting because one would think investors are quite optimistic right now. However, it’s important to note that this indicator is all about margin debt rather than the stock market.

Overall, I found IBD’s Psychological Market Indicators to be somewhat of a mixed bag. I think the CBOE Market Volatility indicator may be the most helpful for investors, followed by the Margin Debt indicator. The Put Call Ratio is especially helpful for options traders. In general though, reviewing all of these indicators on a regular basis could teach users quite a lot about how the market “thinks” about different events. The insight that can be gained from these indicators stretches even beyond what they show at any given moment because investors can put their understanding to work in the long term as well.

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