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How Psychological Indicators Help You Time The Market

The CBOE Market Volatility Index, better known as the VIX, is one of the indicators on the IBD psychological indicators page.

Emotions are unquestionably one of the biggest detriments to an investor's success. Control them, and profits await; let them control you, and disaster can strike.

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But it's not just your emotions that require attention. Mass psychology at extreme levels of fear or overconfidence provide key insights into whether markets are at unsustainable levels.

To that end, IBD provides a Psychological Market Indicators page to assist in gauging market sentiment. Understand that these are secondary indicators — analysis of price and volume of the major market indexes remains primary. However, psychological indicators let you know when the environment may be changing and confirm the chart action.

The Volatility Index, also known by its symbol as "the VIX," uses option activity in the S&P 500 to quantify investors' desire to hedge their portfolios, usually to protect from downside risk.


How To Handle Changing Stock Market Trends


Understanding The VIX

A rise in the VIX suggests elevated levels of fear, hence its nickname "the fear index." IBD has long used the VIX to confirm intermediate and longer-term market bottoms. But it's also useful at flagging short-term market bottoms.

The put/call volume ratio also measures options activity. When the volume in (bearish) puts gets to extremes vs. (bullish) calls, that also suggests a lot of interest in protecting portfolios from downside risk. Again, the fear and desire for protection usually get to their highest levels close to market bottoms.

Another popular contrarian indicator is the Investors Intelligence survey of market newsletters. You would think the professional advisors, the so-called experts, would provide valuable information on market direction. But the more they agree, the more their collective advice tends to be on the wrong side. Professional advisors are human too and susceptible to emotions like the rest of us.

Contrarian Stock Market Indicators

This indicator tends to work best in signaling market bottoms when the percentage of bears exceeds the level of bulls. The more fear there is, even among the experts, the more likely a bottom is near.

Two new psychological indicators also join the page. The High-Low Ratio is a tally of new highs and lows across all indexes and is put into a proprietary ratio. A low number reflects an abundance of lows relative to highs. After reaching extreme lows, an uptick in this ratio can suggest the market is on an upswing.

Finally, the other new indicator helps with major tops, which tend to be more elusive. Tracking Margin Debt can let you know when overconfidence and an absence of fear are ruling investors' emotions.

A top is imminent when more people use margin, or borrowing, to make a killing on a market that continues going up. With an increase of 55% versus the same month of the prior year, you can usually expect a major downturn. The data for this indicator isn't available right away, but since the time frame is on a long-term basis, it gives you ample time to make adjustments.

The new page on Investors.com is available now under the Market Trend Tab and features charts on each indicator with a description and real-time marks when indicators hit critical levels, as well as historical flags using the indicators. This is a premium feature available to subscribers but can also be accessed by taking a free trial.

This article was originally published June 30, 2021 and has been updated.

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