In Finance, what are Sentiment Indicators?

Sentiment indicators are factors that are sometimes used to identify how investors perceive a given market at a particular point in time. The purpose of these indicators is to aid in understanding what situations are leading to these particular perceptions, and what is likely to happen when and if those situations should change. For those who study sentiment indicators, the understanding is that what investors think goes a long way toward moving the marketplace into a state that is either bullish or bearish.

One of the main functions of sentiment indicators is to assess the psychological impact of different market events on the perceptions of investors. This in turn provides some insight into what investors are likely to do next, and how those actions will impact the marketplace as a whole. For example, if investors appear to believe that prices in the marketplace are about to increase steadily for a certain period of time, they are likely to begin buying shares of stock they perceive as being good investments. If enough investors have this perception, and act on it, a bull market may be created.

At the same time, if the sentiment indicators tend to demonstrate that investors believe the marketplace is about to undergo a period where stock prices will decline, chances are high that this will stimulate the sale of securities that are projected to drop in value during the period. When enough investors share this sentiment and begin selling off shares of various securities, this can create a bear market.

Many different elements or factors may be used as part of the process of evaluating the perceptions or sentiments of investors in a given marketplace. Some of the sentiment indicators may have to do with how investors will react to a change in ownership of a major company traded on the market, the anticipated outcome of a political election, or even what investors think will happen in the market when a natural disaster seems imminent. Others may have to do with what investors think will occur if the economy goes through a period of recession or inflation, and how that perception affects their buying and selling habits.

Investors and others may use sentiment indicators as a means of evaluating the upcoming trends in the market and structuring their investment activity to maximize their chances for earning a return. For example, if an investor believes that current sentiment indicators will prompt others to sell shares of securities in anticipation of a decrease in unit price, the investor who believes that the market will recover after a certain period may choose to buy those securities while the prices are low. By holding those securities through the bear market phase, and ultimately earn a great deal when the prices begin to increase once more.