Broad Indices Price Action as an Indicator of Market Sentiment

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Investors and traders know how important it is to understand the general direction of the market. You need to know when prices are going up and down, so you can fine-tune your strategy and avoid buying high and selling low. 

Market sentiment is the overall attitude of the investors towards the financial market; hence, it is important to know how to identify it. Below, we’ll discuss how broad indices price action can be used to gauge the market sentiment. 

Why Are Indices Important?

Indices are used in the world of investment for multiple reasons. They are often used as benchmarks, against which you can compare your portfolio’s performance, so you can see if you performed better or worse than the overall market. If worse, then your strategy is not efficient. 

Another way you can use indices is to hedge (or protect) your portfolio during recessions. You can do so by trading futures when a large portion of your portfolio is invested in stocks. 

For instance, let’s assume your portfolio tracks the Dow Jones Industrial Average Index, which contains 30 prominent companies listed in the U.S. During a recession, when the stock market drops, you can protect your capital if you opt to trade Dow 30 futures in Canada. In this case, since you have a long position, you need to sell (or short) the index futures. The losses in your portfolio are now offset by the gains in the short position. 

How to Use Broad Indices Price Action as an Indicator of Market Sentiment

As mentioned above, market sentiment refers to the general attitude of the investors towards a market or particular security. Large indices, such as the S&P/TSX Composite Index, act as benchmarks. The S&P/TSX Composite Index represents about 70% of the total market capitalization on the Toronto Stock Exchange. Consequently, if this index rises, the market sentiment is bullish and vice-versa.

There are many indicators available to measure market sentiment. One of the simplest ones is the high-low index. Essentially, you choose a broad index, such as S&P/TSX Composite, and compare the number of stocks with 52-week highs to the number of stocks with 52-week lows. If the number is below 30, the market sentiment is bearish. If the number is above 70, the market sentiment is bullish. 

Another way is to compare the 50-day simple moving average (SMA) to the 200-day SMA. If the 50-day SMA is above the 200-day SMA, then it’s a bullish sentiment (prices are increasing); if the 200-day SMA is above the 50-day SMA, then it’s a bearish sentiment. 

Investors can use market sentiment in different strategies. You can use market sentiment to invest based on the market opinion (i.e., if prices are rising, then you buy, hoping to sell at a higher price) or may adopt a contrarian strategy

In this case, you do the opposite action – sell in a bullish market and buy in a bearish market. The premise is that, for instance, if you buy when all prices are going down, you buy cheap, and then sell during a bull market when prices are going up. 


All in all, broad indices can be very helpful when making trading or investment decisions. These can help gauge the market sentiment, based on which you can determine the right timing of your trades according to your well-defined strategy. 

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