A Simple, Powerful (and FREE) Tool Every Investor Should Try

Jan 14, 2022

What would you say if I told you there’s a dead-simple tool that just about anyone can use to make more money with less risk in stocks?

If you’re like most folks, you’d probably be skeptical… or at least assume it would cost an arm and a leg to access it.

Well, I’m here to tell you this tool exists. And in most cases, you can take advantage of it absolutely free of charge.

I’m referring to market sentiment.

Market sentiment is exactly what it sounds like. It’s a measure of how bullish or bearish investors are feeling about a particular market or asset at a particular time.

Why is it useful to know this?

Because it can be an incredibly powerful contrarian indicator.

You see, when we talk about the market, what we’re really referring to is the combined buying and selling decisions of many individuals acting in their own self-interest.

These individuals may use different strategies and approaches to make their decisions. But when you boil it all down, it’s usually pretty simple:

Most folks buy when they believe prices are likely to rise in the future. And they sell when they believe prices are likely to fall.

Or to say it even more simply:

Most folks buy when they’re feeling greedy (bullish) and sell when they’re feeling fearful (bearish).

Now, knowing how any single investor is feeling at a particular time isn’t all that useful. But knowing how a group of many individuals — aka “the market” — is feeling can be incredibly useful.

However, market sentiment doesn’t work the way you might assume.

For example, when most individuals are feeling greedy about stocks, you might take that as a positive sign… as confirmation that a bullish stance is the right one.

However, in practice, this actually tends to be a negative or bearish sign for the market.

Why?

Because it suggests that most investors are already betting that stocks will move higher. And if most folks have already bought, it means there are likely not many people left to buy more and push prices even higher.

In other words, extremely greedy or bullish market sentiment is a warning sign that a rally could be losing steam and a downside reversal is possible.

It works the same way in the other direction too.

When most individuals are feeling fearful about stocks, it tends to be a bullish sign.

It suggests that most investors are expecting more losses. And if most folks have already sold, there likely aren’t many left to sell even more and push prices lower.

So extremely fearful or bearish market sentiment is a sign that a decline could be ending and a new rally is possible.

As you can see, taking advantage of market sentiment isn’t complicated. But there are a few finer points you should understand.

First, sentiment is most useful at extremes. Measures in the middle — from mildly greedy/bullish to mildly fearful/bearish — typically have little predictive value.

Second, sentiment should not be used as a short-term trading tool. Extreme sentiment measures can always become even more extreme before a trend finally reverses. And the timing is always uncertain.

Third, while sentiment can be useful on its own, it works even better when used alongside other tools or indicators.

For example, sentiment can be incredibly powerful when combined with our TradeStops Health Indicator system, Ideas by TradeSmith strategies, or Timing by TradeSmith tools. It can also work well with commonly available indicators like the relative strength index (RSI) or even simple moving averages.

Finally, as I mentioned before, there are many different types of sentiment tools available for investors, each with their own strengths and weaknesses.

So for most folks, I think it makes great sense to use a “composite” tool that combines several different measures into a single, easy-to-read score.

Here at TradeSmith, we recently launched one of our own. The TradeSmith Fear & Greed tool is based on the similarly named Fear & Greed Index from CNN Business.

Our Fear & Greed tool is currently in beta testing and uses many of the same indicators as the original. But we’re working to add several of our own proprietary tools and features to create the most powerful sentiment indicator out there.

If you’re an Ideas by TradeSmith Premium or Lifetime subscriber (which also includes our Trade360 and TradeSmith Platinum members) you can check it out on your TradeSmith Finance Dashboard.

But if you’re not a TradeSmith subscriber, don’t worry.

CNN’s original index works well and is currently available to the public at no cost. You can check it out on their website right here.