Section Seven: Sentiment

Analyze the impact of insider activity on a security’s price action

Insider activity (purchases and sales by corporate officers, directors, and beneficial owners of >10% equity stakes) can provide timely signals about security price movements. Insiders typically file purchases because they believe stock is undervalued, making insider buying a bullish signal. One study found insider purchase portfolios earn abnormal returns exceeding 50 basis points per month, with one-quarter of returns accruing within 5 days and one-half within one month. Insider selling is less significant as it can reflect diversification, personal needs, or estate planning rather than sentiment.

Compare insider buying versus insider selling

Insider buying is generally more significant than selling. Insider buying indicates conviction that the stock is undervalued and carries strong timing signals. Insider selling, while not necessarily bearish, is done for numerous non-sentiment reasons (portfolio diversification, tax planning, charitable gifts). However, clusters of multiple insiders selling large positions simultaneously can indicate bearish sentiment. Abnormal returns from insider buying are statistically significant; abnormal returns from insider selling are not.

Analyze short interest and the short interest ratio

Short interest is the total number of shares sold short that have not yet been repurchased. The short interest ratio (also called “Days-to-Cover” or DTC) is calculated as: aggregate short interest divided by average daily share volume. A high short interest ratio indicates investors expect the stock to decline. This can be interpreted contrarially: if short interest is very high, short sellers will suffer losses if the stock rallies and may cover by buying shares, creating upward buying pressure. Some analysts view high short interest as a bullish indicator.

Interpret sentiment as drawn from surveys of investors and professionals

Survey-based sentiment includes:

• AAII Survey: Measures individual investor sentiment. Extreme neutral sentiment (expecting unchanged prices) has preceded 26-week SPX gains averaging 8.6% and 52-week gains of 17.7%, significantly exceeding median historical returns (5.2% and 10.7%).

• Investors Intelligence Advisors’ Sentiment Report: Surveys 100+ independent investment newsletters (not affiliated with brokerages). Reported as percentages of bullish, bearish, and correction-expecting advisors. Interpreted as a contrarian indicator: >60% bullish usually precedes pullbacks; ≥55% bearish marks bottoms (rare, ~10 times since 1987).

Both analyst sentiment and individual investor sentiment serve as contrary indicators; extreme bullishness marks market tops while bearishness indicates downtrend and reversal proximity.

Interpret changes in futures open interest in the context of price action

Open interest is the total number of outstanding futures contracts not yet settled by offsetting trade or delivery. Changes in open interest reveal market sentiment:

Price Trend	Open Interest Change	Interpretation
Uptrend	Increasing	Uptrend likely to continue (new money entering)
Uptrend	Decreasing	Uptrend likely to reverse (money exiting)
Downtrend	Increasing	Downtrend likely to continue (new money entering)
Downtrend	Decreasing	Downtrend likely to reverse (money exiting)

Steady open interest is an early warning of trend reversal but not an urgent signal.

Analyze the Commitments of Traders report

The Commodity Futures Trading Commission (CFTC) requires large traders to report positions weekly. The Commitments of Traders (COT) report aggregates data into categories:

• Commercials (lowest line): Producers and industrial users hedging real exposure; viewed as “smart money” because they understand market fundamentals

• Large Speculators (top line): Hedge funds, CTAs; often trend-followers who buy during rallies and sell during declines

• Small Speculators (middle line): Remaining open interest; often wrong in futures markets

A commercials’ shift toward less bearish (more bullish) positioning, combined with large speculators reducing net long positions, signals potential upside moves and market bottoms.

Employ options put/call ratios as sentiment indicators

The put/call (P/C) ratio compares put volume (or open interest) to call volume. Rising ratios indicate increased put buying relative to calls, signaling higher bearishness and fear. Falling ratios indicate reduction in puts relative to calls, signaling lower bearishness. The P/C ratio is interpreted contrarially: rising ratios (high bearishness) are bullish in the short run; falling ratios (low bearishness) are bearish.

Interpret volatility data drawn from the options market

The VIX (Cboe Volatility Index) measures 30-day expected volatility of the S&P 500, derived from real-time, mid-quote prices of S&P 500 Index call and put options. Higher VIX implies greater expected volatility in the next 30 days. VIX tends to spike at market bottoms, earning its nickname “fear index.”

However, real-time interpretation is difficult; no objective level definitively signals bottoms. VIX cannot be traded directly but is tradable via options, futures, and derivatives. Additional volatility indexes (VVIX, GVZ, etc.) track other assets; increases in any volatility index indicate expected price volatility regardless of directional impact.