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) continues to confirm the uptrend in the market. However, it is starting to diverge on a daily basis. This divergence comes as a result of traders doubting SPX can continue to rally at the same pace. The Twitter stream was filled with bearish tweets early in the week, but the comments by Ben Bernanke on Wednesday moved many of the bears to anger and the rest to capitulation. The bulls are showing more surprise than excitement. They liked the move, but didn’t expect the strength. There were a lot of tweets mentioning short covering, which we consider bullish, but prefer to see them near market lows rather than highs.

Smoothed sentiment is just below the highest levels it’s ever printed. As long time readers know, this isn’t a contrary indicator suggesting that the market should fall. Instead, it is confirming the move to new highs. Previous high readings in smoothed sentiment resulted in several weeks of higher prices. For warning that the market might consolidate we look first for smoothed sentiment to paint a negative divergence from price, then a break of its prevailing (confirming) up trend line.

It is interesting to note that the reconfirmation of the larger trend (or buy signal) in early June was not negated by a break of the prevailing up trend line. The perceived hawkish comments by Ben Bernanke created a large downward move in price that was not confirmed with persistent negative sentiment. This occurred due to the positive tweets mentioning other Fed officials trying to calm fears in the face of falling prices. This is reflected in daily sentiment painting one sharply negative reading then quickly moving higher (even as price fell for a few more days).

I suspect that this was no solace to traders (on the long side) as it would have been difficult hold short term positions in the face of such sharp selling. As longer term investors, it was one arrow in our quiver that gave us a bit more confidence to wait patiently for more information rather than making hasty adjustments to our portfolios. We like to see several indicators confirming moves in price before hedging or raising cash. Near the lows in June we saw several of our indicators very close to warning signals at the same time as sentiment on the Twitter stream was a whisper away from warning. Those conditions created a good inflection point for longer term investors. A break lower would have been confirmed in several ways making it easy to raise cash or hedge. While a recovery from that point (with confirmation from many indicators) would have kept us comfortable staying long. We ended up with a rocky start to the rally, but following our discipline kept us long during a trying decline.

Twitter support and resistance levels basically disappeared over the past week. There are scattered tweets above the market at 1687, 1700, and 1750. Below the market 1650 and 1600 are the most tweeted levels. But for the most part the price target tweets are simply chasing price. This signals that swing traders aren’t active. They’re waiting before committing themselves.

Sector sentiment has every sector with a positive bias which can be interpreted as either bullish, with everything rallying together, or an indication of some defensive rotation going on under the covers. This is a condition that hasn’t occurred since we started tracking sector sentiment. However, we have seen every sector negative before. That occurred at the lows in April … I won’t draw any conclusions since one instance makes a poor sample set.

So what now? This is a good place for the market to pause before moving higher. Smoothed sentiment is confirming this rally so we have to conclude that there will be higher prices in the future, but several indications from sentiment suggest a short term pause. Daily sentiment is starting to diverge from price, traders aren’t targeting higher prices in substantial volume, and sector sentiment isn’t providing any guidance. A large volume of tweets mentioning short covering near a market high could indicate buying exhaustion. All of that adds up to a good place for a short term dip that is subsequently bought by market participants who missed the rally or were whip sawed by the Fed induced to taper or not taper decline.

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.