Gauging Investor Sentiment with Twitter: New Update

Courtesy of Doug Short.

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The Downside Hedge Twitter sentiment indicator for the S&P 500 Index (SPX) is painting moderately high readings on up days and fairly flat reading on down days. This is a positive sign for a market making new highs. Even though there continues to be a very large number of tweets concerned with overbought conditions there are enough tweets showing excitement about higher prices that the daily indicator doesn’t travel far below zero.

The concern about overbought conditions is showing up in smoothed sentiment as a negative divergence with price. As prices move higher more traders are showing skepticism. This indicates that the probability of a pull back in the near term is rising. Unfortunately we don’t have the conditions in place to issue a consolidation warning if price pulls back immediately.

There are two things necessary for a consolidation warning. First we need a solid uptrend line in smoothed sentiment that confirms the move in price. At this point we feel it’s too early to use the last low as a reference point. Our second condition is a divergence from price that lasts at least three weeks and preferably a month that subsequently breaks our uptrend line. The current divergence has only been in place a few weeks. The reason we prefer a longer divergence is that people change their minds slowly. It often takes several days and even weeks for the weight of evidence to build to a point where market participants move from bullish to bearish. In the current environment we see more traders get concerned about overbought conditions every day. This is showing up in moderately high daily sentiment readings on very strong price moves (and the negative divergence in smoothed sentiment mentioned earlier). At this point we have warning that traders are getting concerned, but no warning of a possible decline.

Support and resistance levels generated from the Twitter stream pointed at 1700 on SPX and almost nothing else. There were a lot of tweets mentioning the current price during each day, but not a lot of predictions. The market closed barely above previous resistance of 1665 on Friday. We like to see a market close above a resistance level for a few days before we call it support so 1665 on SPX remains resistance. Below the market 1650 is a small support level, but 1600 is where we find major support.

Sentiment for the various market sectors improved almost across the board. It appears that everything is being bought. Even with strong support for financials, technology, and energy the defensive stocks had a positive bias. One thing of note is that sentiment for consumer discretionary stocks and basic materials fell. It appears as if market participants continue to rotate away from the highest performing sectors to the sectors that have lagged throughout the year. This is the fuel that is driving the current rally.

From a sentiment perspective the market is in a frenzy. Overbought conditions can’t bring daily sentiment far below zero. Traders are targeting 1700 on SPX and nothing else. Meanwhile, every sector is showing positive sentiment readings. Right now we can’t tell when it will end so we’re simply enjoying the gains.

Note: I’ve created a video that focuses on how I use the indicator to trade individual stocks.

Here’s some written explanation about the video that clarifies some things and also describes what the annotations on the charts mean.

Here also is a download page so readers can load the sentiment indicator into their own chart packages. It’s located here.

Here is an earlier YouTube video that a basic explanation of the indicator.

Blair Jensen at Downside Hedge tracks Twitter sentiment and provides hedging strategies for individual investors.