There are all kinds of indicators and metrics in the stock market that assist traders and investors. Don't Be The Dumb Money One type of indicator in the stock market is known as the "contrarian signal". This is a market indicator which indicates the opposite…
There are all kinds of indicators and metrics in the stock market that assist traders and investors.
One type of indicator in the stock market is known as the “contrarian signal”. This is a market indicator which indicates the opposite of what one might intuitively conclude from the signal itself.
One such stock market indicator is the “dumb money confidence index”. For better or for worse, it is generally regarded that institutional and hedge fund investors are smarter than individual retail investors.
Consequently, individual retail investors are known as “dumb money”.
The theory behind confidence indicators is that if everyone is bullish and/or confident, then all of the people who could be buying securities in the stock market are already in the market. That suggests that the market is closer to a top.
The reverse is also true. If everyone is bearish and/or not confident, then all of the people who could be selling securities in the stock market have already sold out of the market. That suggests that the market is closer to a bottom.
The chart below is a contrarian indicator.
A regular survey of the stock market’s smart money currently shows that only 31% are confident in the state of the stock market, while the dumb money has 79% confidence.
This can be interpreted to mean that the dumb money, or the retail investor, doesn’t realize that the stock market is close to a top.
This is supported by the Shiller price-to-earnings ratio, which is an inflation-adjusted metric that shows the stock market is presently at its second most expensive valuation in history.
The stock market is nearly 100% above its mean valuation, suggesting the market needs to crash by as much as 50% for its overall valuation to revert to the long-term average.
There are two other similar indicators that investors may be interested in.
The weekly American Association of Individual Investors Bull and Bear Survey is another type of contrarian indicator.
It operates under the same theory, namely, that the time to buy is when pessimism and fear are at a maximum, and therefore investors are the most bearish.
The time to sell is when optimism and greed are at a maximum, and therefore investors are the most bullish.
The latest survey shows 35.9% bullish, 35.4% neutral, and 20.6% bearish.
The long-term historical average of bullishness is 38.5%. So this particular indicator does not align with the dumb money confidence index.
Generally speaking, extreme degrees of sentiment on this index tend to be indicative of large market moves.
The put-call ratio shows information regarding the relative trading volumes of put options (which are bearish) to call options (which are bullish).
A ratio above one is generally considered to be an indicator of a coming selloff, but since it is a contrarian indicator, many traders see this as excessive pessimism and a buying signal.
Again, extreme spikes in this ratio tend to indicate large market moves.
The current total put-call ratio on the entire stock market is 1.09, which is not terribly extreme. However, the put-call ratio on indices is 1.42, suggesting high levels of pessimism.
Last modified: January 11, 2020 1:00 AM UTC