Kentor asset management - retail investors

retail investors are more emotional than professionals and tend to become more excited about (or discouraged by) a trend the longer the trend persists. in the short-run, this means that individual investor sentiment is actually a less reliable contrarian indicator, since trends often continue for much longer than the pros expect, but extreme sentiment among individuals is almost always a good indication of an imminent reversal in the long-term trend. one of our favorite measurements of retail investor sentiment is the monthly ubs/gallup index of investor optimism. in addition to investor surveys, we closely track mutual fund flows for signs of extremes in various categories, such as stocks vs. bonds, foreign vs. u.s., growth vs. value, etc. an excellent source for these data is trimtabs investment research.
we also monitor the volume of put option contracts (a bet that the market will fall) versus call option contracts (a bet that the market will rise), having found that the 10-day and 60-day moving averages for the cboe total put/call ratio are excellent gauges of the overall level of fear in the market. from 2003 through 2006, every major buying opportunity on weakness was marked by several consecutive days of a 1.0 reading on the 10-day average, and the 60-day average rarely fell below the relatively high level of 0.80. by contrast, at stock market peak in 2000, immediately prior to the start of the 2000-02 bear market, the 60-day put/call ratio fell below 0.50.
another important indicator of extreme sentiment in the market is very high or very low short interest on an overall stock exchange, such as the nyse and the nasdaq, or for a specific exchange traded fund. because every share of stock sold short must be bought back eventually, extremely high short interest levels are an important indication of strong future demand and suggest that downside risk is limited. conversely, very low levels of short interest reflect complacency on the part of bulls and capitulation on the part of bears – a signal that future demand will likely be weaker.
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