Investors consider several factors when assessing the value of an asset, ranging from economic indicators such as interest rates and inflation to wider geopolitical events and natural disasters. Their decisions are typically based on matters that can be empirically evaluated and logically derived.
However, many shrewd investors also take into account certain psychological factors and their impact on a particular market when making investment decisions. The ability to gauge the collective mood or ‘sentiment’ of the market can empower investors to understand some of the driving forces behind the valuation of an asset which may not be readily evident from empirical data alone.
In this article, we will take a closer look at how market sentiment can give investors a better understanding of a particular market, enabling them to make smarter investment decisions.
What is Market Sentiment?
Historical events have shown the effect that emotions and attitudes can have on the value of an asset. Commonly, referred to as either ‘bull’ or ‘bear’ markets, these sentiments are often driven by the fears, hopes, and greed of investors. In extreme cases, they can lead to the collapse of long-standing institutions and a chain reaction that ripples out into the entire financial system of a country.
In other cases, excessive greed or optimism can cause the value of an asset to skyrocket to heights that grossly exceed its intrinsic worth, leading to price bubbles and eventual crashes.
Recognising the impact that market sentiment can have on a market and the value of an asset as well as being aware of one’s own motivations for investing can help individuals make more informed investment choices.
Investor Advantage
Whether you are looking to invest in real estate or buy Bitcoin, a greater understanding of market sentiment can offer the following advantages:
- Spot opportunities: An anticipation of market sentiment can help investors spot opportunities ahead of time, enabling them to time their investment decisions at a price that yields the greatest return.
- Maintain objectivity: By avoiding emotionally fuelled decisions, investors can remain objective, helping them withstand much of the short-term volatility caused by market sentiment. This positions them well to achieve growth over the long term.
- Manage risk: By recognising the influence that market sentiment has on asset values, investors can adjust their investment strategies to minimise losses and build more balanced portfolios.
Gauging Market Sentiment
The key indicators listed below can help investors gauge market sentiment and make more informed investment decisions:
- CBOE Volatility Index (VIX): The VIX index measures expected volatility in the stock market over a 30-day period.
- Fear and Greed Index: This index can help investors gauge market sentiment in the stock market. The index uses a scale of 0 to 100, measuring extreme fear to extreme greed. Investors in the crypto market can take advantage of a similar index called the Crypto Fear and Greed Index.
- Social media: Social media analysis can reveal early indications of market sentiment, trends, and potential movements in a market.
By factoring in the importance of market sentiment in their decision-making, investors can enhance their ability to spot opportunities and mitigate their risks.