Sentiment indicators: can they really lead the market?
For the short term technical investor a perenial question is which indicators to follow; does the RSI give a truer picture than the ADX, should an MACD cross-over signal be followed etc… Whatever your personal preference, a common criticism of price indicators is that they are by their nature, lagging. They tell you when a trend has already started, not when it is about to start.
So what if there was a leading indicator which didn’t rely on historical prices and which anticipated movements rather than measuring them?
With that question in mind the MoneyVidya team has devised the MoneyVidya Community Strength Index (MVCSI). The indicator is based on the Relative Strength Index but the underlying driver is not stock price movement it is movement in the volume of Buy and Sell picks made on MoneyVidya.com.
The logic behind this is that the Indian markets (now more than ever) are sentiment driven. If you can measure sentiment it informs your view of where prices are going. An upmove in sentiment anticipates an upmove in price (and vice versa). So how do you measure sentiment?
The approach we have taken is to track the volume of Buy picks Vs Sell picks. When sentiment is positive members make more Buy picks, when it turns negative members make more Sell picks. Creating an oscillator out of the volume of Buy and Sell picks allows you to summarise sentiment and anticipate price movements.
This all sounds good but does this idea actually work?
Well the honest answer is that the 3 months of data which the MVCSI is based on is not enough to conclusively say either way, but the early signals are positive. Below is a chart of the Nifty, the MoneyVidya Comunity Strength Index (MVCSI) and the 14 period RSI;
Overall the pattern of movements in the MVCSI largely reflects the traditional RSI despite the fact that it is not based on price movement at all. One noticeable difference is that there is a slight shift to the left (leading rather than lagging). As an example, the movement from Oversold to normal conditions on the MVCSI, which would be a strong bullish signal, occurs several days befor e the March rally actually begun.
The other noticeable difference is that the magnitude of movements is not always the same. For example the downturn in the MVSCI from the Overbought high point is much more accute than for the RSI. This illustrates the fact that despite a lack of confidence at the time (negative sentiment), inflows of foreign funds drove the markets higher, essentially suprising people.
This point comes to the crux of the matter. As a sentiment indicator the MVCSI has the potential to lead the market in a way that price based indicators cannot. However sentiment (even mass sentiment) is sometimes wrong, in a way that prices cannot be.
With a three month track record it is hard to say anything conclusive regarding the MVCSI. Whether it continues to prove itself remains to be seen. However as the MoneyVidya.com community grows and the volume of picks increases it is likely to increase in accuracy when measuring mass sentiment. Whether this sentiment will reflect what happens in the markets is the question which remains to be answered.
Loading...