You will be able to read volume, market breadth and sentiment data as context for the state of the market.
One afternoon the STI rose 1.5% and Marcus's colleague announced that the market was "back". Marcus opened the market summary on his broker app. The index was up, but more SGX stocks had fallen than risen that day, trading was thinner than usual, and almost all the gain came from two of the three banks. The index had told one story. The rest of the market had told another.
Price charts show what happened to one line. Volume, breadth and sentiment measures add context: how many people took part, how many stocks joined in, and how investors feel. This lesson covers what each one shows and how far to trust it. Nothing here is a timing signal, and figures are made up unless a source is named.
Volume is the number of shares traded in a period. A price move on heavy volume means many buyers and sellers agreed on the new price. A move on light volume means few did, and a move with little participation is easier to reverse, because the next large order can push the price back.
Volume is most useful compared with its own average. If Larkspur usually trades 0.6 million shares a day, the made-up figure from lesson 5.4, Index construction and what inclusion does to a stock, then a day of 3 million shares stands out. It tells you something happened. It doesn't tell you what. Heavy volume on a rise can be eager buying, a fund building a position or index funds buying at a rebalance, and lesson 5.4 showed how mechanical that last kind can be. Read the announcements before you read anything into a volume spike.
An index weighted by market value, as lesson 5.4 explained, can rise on the back of a handful of large companies while most of its members fall. Market breadth measures how widely a move is shared.
The simplest measure counts advancing and declining stocks each day. A running total of advances minus declines, called the advance-decline line, shows whether participation is widening or shrinking over time. Another common measure is the share of an index's members trading above their own 200-day moving average. If the index is near a high but only 40% of its members are above their 200-day averages, the rise rests on a narrow base.
Narrow rallies aren't doomed. Large companies can carry an index for years, as the biggest US technology companies have at times. But a narrow rally is more fragile, because it depends on a few names, and it tells you that an index fund holder's experience and a typical stock picker's may be diverging.
Sentiment measures try to capture mood, and they come from three kinds of source.
The first is option prices. The VIX, calculated by Cboe from the prices of S&P 500 index options, measures the volatility the options market expects over the next 30 days, using the implied volatility from lesson 5.7, Options basics: payoffs and the Greeks, so you can read prices. It rises when investors pay up for protection, which is why it's called a fear gauge. In March 2020 it reached its highest closing level on record, above its peak in late 2008.
The second is trading activity. A put-call ratio divides the volume of put options traded by the volume of calls. Since puts protect against falls, a high ratio suggests investors are buying protection.
The third is surveys. The American Association of Individual Investors runs a weekly survey asking members whether they expect US shares to rise, fall or stay flat over the next six months, and publishes the share in each camp. Other surveys ask fund managers about their positioning.
Sentiment measures swing between extremes, and the extremes are what traders watch. The usual reading is contrarian: when almost everyone is fearful, much of the bad news may already be in prices, and when almost everyone is confident, there may be few buyers left.
There's something to this as context. Very high fear has often appeared near market lows, because lows are when people are most frightened. The trouble is timing. Fear can rise further after it looks extreme, and a market can stay calm and confident for years. In late 2008 the VIX was already very high in October, and shares kept falling until March 2009. Anyone who bought on the first fear reading sat through months of further losses. Extreme sentiment has been more useful for knowing what kind of market you're in than for picking the day it turns.
None of these measures means much alone. Marcus added three rows to the macro dashboard he built in lesson 3.8, Write a macro dashboard and three scenarios: the VIX, the share of STI members above their 200-day averages, and the AAII survey's bullish minus bearish reading. Like the other rows, each gets a value, a direction and a date.
He wrote a rule beside them, in the spirit of the one that ends that dashboard: "These rows describe conditions. They can prompt me to reread my rules, never to trade." On a day when the VIX is high, breadth is collapsing and the survey shows deep pessimism, the useful action is to check that his rebalancing bands and cash needs are where he wants them, so a fall finds him prepared rather than reacting.
For the activity, you'll look up the latest VIX from Cboe or a finance site, one breadth measure for an index you hold and the latest reading of one investor sentiment survey, all dated today.
Record the current VIX, one breadth measure and one investor sentiment survey, and write what they say together.
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