Sentiment Indicators and Positioning Data

Crowd psychology moves markets at extremes. When everyone is bullish, who is left to buy? When pessimism reaches a crescendo, selling pressure exhausts itself. Sentiment indicators quantify these psychological states, providing contrarian signals when readings reach extremes. This article covers the major sentiment measures, how to interpret them, and how to avoid their common pitfalls.

The Logic of Sentiment Analysis

Sentiment analysis rests on a contrarian premise: extreme optimism precedes tops, and extreme pessimism precedes bottoms.

Why this works:

Important caveats:

1. Extremes can persist. Sentiment can remain bullish for months during strong trends.
2. Sentiment works better at bottoms than tops. Fear is a sharper emotion than greed.
3. Sentiment alone is not a timing tool. Combine with price action and other indicators.

AAII and Investors Intelligence Surveys

Survey-based sentiment measures ask investors directly about their outlook.

AAII Investor Sentiment Survey

The American Association of Individual Investors surveys members weekly on their 6-month stock market outlook.

Historical context:

• Long-term average: 37.5% bullish
• 2000 peak: 75% bullish (January 2000)
• 2009 bottom: 18.9% bullish (March 2009)
• 2020 bottom: 20.3% bullish (March 2020)

Bull-Bear Spread:

The difference between bullish and bearish respondents provides a cleaner signal:

Investors Intelligence Survey

This survey tracks investment newsletter writers rather than individual investors.

Why newsletter writers matter: They influence their subscribers' behavior and are themselves reactive to recent market moves. When nearly all newsletters are bullish, their readers are likely fully invested.

Survey limitations:

• Surveys measure stated sentiment, not actual positioning
• Respondents may have different definitions of "bullish" or "bearish"
• Retail sentiment may not reflect institutional positioning
• Weekly surveys introduce timing imprecision

Put-Call Ratios and Options Market Signals

Options markets provide real-money sentiment signals. Traders back their opinions with capital.

CBOE Equity Put-Call Ratio

This ratio measures put volume divided by call volume.

Smoothing matters: Daily readings are noisy. Use 5-day or 10-day moving averages.

Historical extremes:

VIX Term Structure

The VIX measures expected S&P 500 volatility over 30 days. The term structure (comparing near-term versus longer-term VIX futures) reveals positioning.

VIX level interpretation:

VIX spikes and opportunities:

Interpretation: VIX spikes above 35-40 historically mark excellent intermediate-term buying opportunities. However, timing the exact bottom is difficult.

COT Report for Futures Positioning

The Commitment of Traders (COT) report reveals positioning in futures markets by trader category.

Understanding trader categories:

S&P 500 Futures Positioning:

What defines "extreme":

Look at historical percentiles:

• Above 90th percentile (net long): Extreme bullishness
• Below 10th percentile (net short or low long): Extreme bearishness

COT signals in practice:

Accessing COT data:

• CFTC releases data every Friday at 3:30 PM ET
• Data reflects positions as of Tuesday
• Free access at cftc.gov
• Charting at Barchart.com or TradingView

Fund Flow Data Interpretation

Fund flows reveal what investors are actually doing with their money.

Key flow metrics:

Interpretation framework:

Historical examples:

Money market fund levels:

High money market balances indicate dry powder on the sidelines:

As of late 2023, money market funds held over $6 trillion, near record levels, suggesting significant cash available for equity allocation.

Contrarian Uses of Sentiment Extremes

Sentiment indicators work best as contrarian signals at extremes, not as trend-following tools.

The contrarian framework:

Combining indicators for signal strength:

Scoring example:

+3 = moderately bullish sentiment signal (not extreme, but tilted)

March 2020 case study:

This was as clear a sentiment extreme as exists. The S&P 500 returned 68% over the next year.

Pitfalls and Limitations

Pitfall 1: Acting on moderate readings

Sentiment is only useful at extremes. A put-call ratio of 0.75 or AAII bullish at 42% provides no actionable signal.

Pitfall 2: Ignoring trend

In strong trends, sentiment can remain extreme for extended periods. Bull markets can maintain elevated bullish sentiment for years. Use sentiment with price action, not instead of it.

Pitfall 3: Timing expectations

Sentiment extremes identify conditions, not precise timing. An extreme reading can persist for weeks before price reacts. Build positions over time.

Pitfall 4: Single indicator reliance

One indicator at extreme is suggestive. Three or more at extreme is compelling. Always combine indicators.

Pitfall 5: Ignoring structural changes

Options market structure has changed with the rise of 0DTE (zero days to expiration) trading. Put-call ratios may not mean what they once did. Monitor indicator reliability over time.

Building a Sentiment Dashboard

Weekly monitoring checklist:

Simple scoring system:

Assign +1 for each bearish extreme (contrarian bullish), -1 for each bullish extreme (contrarian bearish), 0 for neutral:

Monthly review questions:

• Which indicators reached extreme readings?
• Did price action confirm or contradict sentiment signals?
• Are any indicators losing reliability?
• How does current reading compare to prior extremes?

Summary

Sentiment indicators measure market psychology through surveys, options positioning, futures data, and fund flows. Extremes in these measures historically precede reversals: extreme pessimism marks bottoms, extreme optimism marks tops. The AAII and Investors Intelligence surveys provide direct sentiment readings. Put-call ratios and VIX reveal options market fear and complacency. COT reports show futures positioning by trader type. Fund flows reveal what investors are actually doing with their capital. Combine multiple indicators rather than relying on any single measure. Act only on extremes, not moderate readings. Use sentiment as a contrarian overlay to other analysis, not as a standalone timing tool. When three or more indicators reach extreme pessimism simultaneously, history strongly favors adding equity exposure; when they reach extreme optimism, history favors defensive positioning.