FI Pillar: Sentiment
Sentiment measures the psychology of markets—how investors feel and position themselves in relation to risk and opportunity. This pillar reflects tone, positioning, and behavioral indicators that often precede market turns.
Why Sentiment Matters
Market sentiment drives short-term momentum and can reveal extremes of greed or fear. When optimism runs too high, markets often correct; when pessimism peaks, opportunity arises. Sentiment doesn’t change fundamentals but influences timing, flows, and volatility. Tracking positioning and tone helps investors stay balanced through emotional cycles.
Key Metrics and Their Importance
1. Flows
Why it’s important: Fund flows reveal where investor capital is moving—toward risk assets, safety, or cash. Persistent inflows indicate rising confidence, while outflows reflect fear or de-risking.
Factors involved: ETF and mutual fund flows, sector rotation trends, and foreign vs. domestic asset preferences. EPFR and Bloomberg flow data help gauge investor conviction.
2. Surveys
Why it’s important: Investor and consumer sentiment surveys provide qualitative insight into market tone. Extreme optimism or pessimism often signals turning points.
Factors involved: AAII Bull-Bear spread, Investors Intelligence readings, and University of Michigan consumer sentiment index. Survey divergences from price trends can be early warning signs.
3. Put/Call Ratios
Why it’s important: Put/Call ratios measure the volume of bearish versus bullish options trades. A high ratio suggests fear, while a low ratio implies excessive optimism.
Factors involved: Index vs. single-stock ratios, short-term vs. long-term contracts, and changes in implied volatility. The 5–10 day average smooths noise for clearer signals.
4. Short Interest
Why it’s important: Short interest reflects the percentage of shares sold short relative to total float. Rising short interest signals bearishness, while declines indicate improving confidence.
Factors involved: Days-to-cover ratios, sector dispersion, and changes following earnings or policy shifts. High short interest can trigger short squeezes in rallies.
5. AAII & NAAIM Exposure
Why it’s important: The American Association of Individual Investors (AAII) and National Association of Active Investment Managers (NAAIM) exposure indexes track positioning across retail and professional investors. Their extremes often coincide with sentiment inflection points.
Factors involved: Weekly NAAIM exposure index, AAII bullish/bearish ratios, and changes around market peaks and troughs. Combined, they provide a comprehensive view of crowd psychology.