Stockpickr) -- Sentiment is a crucial part of market pricing. Ultimately, sentiment -- how investors
feel about a stock, commodity or any other investment -- is key to what they're willing to pay for it. Sentiment indicators are a means of quantifying the feeling among different investor groups. As a result, they're a powerful tool for any
technical primer, we'll take a look at some of the most useful sentiment indicators out there.
Sentiment indicators are especially helpful when used with contrarian investing strategies (if you missed our primer on contrarian investing,
you can read it here). In short, they provide an added way of seeing exactly what the crowd is thinking. Better, they help us see what different members of the crowd are thinking.
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That's an important distinction -- after all, the stocks that grandma is buying might be different from the investments that a hedge fund manager or commodities trading advisor are making. The fact that we have that level of granularity over sentiment indicators is particularly helpful.
A Rundown on Sentiment Indicators
So what sentiment indicators should you have on your radar? Here's a quick rundown.
Even though these indicators may look at disparate data sources to calculate sentiment readings, there is a common thread: Generally, extremes in these sentiment indicators are a much more important signal to traders than the readings are themselves. From a contrarian standpoint, a historic extreme in bullish sentiment is a sign that its time to exit the market.
VIX Volatility Index
It makes sense to start off with what's probably the most popular sentiment indicator out there: the
VIX Volatility Index
. Most traders think that the VIX is a volatility indicator (as its name implies), but frankly it's not a very good one. It's better suited to its nickname: a "fear gauge." That's because the VIX doesn't measure true statistical volatility of a stock; it's a measure of the volatility being priced into the market by investors.
It's also important to remember that the VIX doesn't move equally in both directions; instead, it's biased toward downside volatility. The quick and dirty analysis is that a high VIX reading indicates a fearful market -- and a potentially good contrarian buying opportunity.