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Quantifying Stock Market Sentiments

by | Tips & Strategies

If anything can be gleaned from the intersection of markets and politics over this election, it’s that stocks delight in stability and abhor chaos. This idea isn’t novel or groundbreaking. In fact, it’s been iterated and reiterated by several pundits across almost every network in the last week.

But what does this mean for traders? Can “delight” or “abhorrence” be quantified? Is there opportunity as the collective lens goes in and out of focus on an event such as the presidential election?

To answer these questions, assumptions need to be made:

  1. Delight = +3% daily move in Small Technology (STIX)
  2. Abhorrence = -3% daily move in Small Technology (STIX)

Why +/-3% daily moves? They occur about 5% of the time, which equates to two standard deviations; and STIX has witnessed 2 such moves in the last 5 trading days (40% of the time).

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11062020_ Chart
Source: dxFeed Index Services (https://indexit.dxfeed.com)

Human nature around these outliers usually dictates that, “the market is crashing/flying, so I should sell/buy.” But there are a few flaws with this plan: you don’t know it’s an outlier until it’s too late; you’ll be inactive for months trying to predict an outlier (ask black swan fund managers); there usually aren’t too many more points to profit from after a +/-3% move.

And then there’s the historical data that says markets are more likely to reverse than continue. It may seem counterintuitive to plan for rain when the sun is shining on stocks, but selling into extreme strength and vice versa has been a consistent trade no matter the market’s mood.

Moody Markets STIX Movement Following Daily Extremes

11062020_StandardDeviation
Source: dxFeed Index Services (https://indexit.dxfeed.com)

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