Measure the overall bullish or bearish attitude
Contrarian market indicators attempt to measure the overall bullish or bearish attitude towards the market among traders and investors (market sentiment) or they track the investing behavior of Smart Money and Dumb Money. Those indicators do lead or confirm price actions.
According to accepted valuation theory, stock prices reflect collective investor expectations of future developments and risk. But in reality, most investors spend much time trying to understand a stock's current fundamentals and too little time gauging the expectations embedded in its price.
A contrarian investor or the behavioral finance followers believe that when everybody is fully invested there will be no further purchasing power. At this point, the market is at a peak. On the other hand, when people predict a downturn, they have already sold out, at which point the market can only go up. Normally when the market hits a new low, Smart Money will buy and Dumb Money will sell. Therefore following the behavior of Smart- and Dumb Money will give additional edge of information about the general market condition.
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Examples of Different Contrarian Indicators Offered by WallStreetCourier
Bull & Bear AII
The Bull & Bear AAII (American Association of Individual Investors) is a key sentiment indicator for stock market technical analysis. Contrarian theory states the time to buy is when fear and pessimism are at a maximum since this usually occurs near market bottoms. The sentiment survey, taken once and it measures the percentage of individual investors who are bullish, neutral and bearish. |
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Global Futures Dumb Money Index
The Global Futures Dumb Money Index is calculated according to a proprietary formula of WallStreetCourier. It shows tops when the so called "crowd" gets too bullish. Some of the components of this indicator are the Global Futures Sentiment Index, the CBOE call/put ratio of equity options and the ISE Sentiment Index. |
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Smart Money Flow Index
The Smart Money Flow Index is calculated according to a special formula by taking the action of the Dow in two time periods: the first 30 minutes (dumb money) and the last hour (smart money). The value of this indicator lies in its comparison to the Dow - we want the SMI to perform better or worse than the Dow. Any non-confirmation indicates a change of the prevailing trend. It is a clear buy signal if the Dow falls to a new low which is not confirmed by the SMFI or whenever the Dow makes a high which is not confirmed by the SMFI there is trouble ahead. |
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Daily Put/Call Ratio All CBOE Options
The buying and selling activity for puts and calls can be used to help gauge investor sentiment in the market. The put call ratio measures the relationship between the numbers of puts being bought versus calls being bought. This indicator takes into account all of the options traded at the CBOE. High put/call ratios are often indicative of excessive pessimism and thus of large amounts of money on being at the "sidelines." Conversely, low put/call ratios indicate a point at which there is so much optimism that very little money is left to push the stock or index higher. |
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The Advantage and the Complicacy of Contrarian Indicators
Contrarian Indicators are designed to track the sentiment of different investors. Most of the contrarian indicators lead prices and in comparison with oscillators they do work in every market phase (trends and trading ranges). Somehow they are a mixture between trend- and breadth indicators as well as oscillators. If a contrarian indicator flashes a divergence that does not necessarily lead to a major price reversal. Nevertheless contrarian indicators could be an important red flag on the horizon for traders. |
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