There was an interesting segment on Bloomberg TV today about the stock market. If you didn’t click on the link, Blooberg equities analyst Dominic Chu points out that the most shorted stocks during last December outperformed the S%P 500 during the same period. If everyone was expecting these stocks to go down (shorted), then how come they went up?
That’s a good question. Maybe we should ask Chu, or keep watching the video; because he offers some good explanations. I’m using the video to compare the stock market with Forex, because a lot of the metrics are applicable to both. In this case specifically, where you have large hedge funds investing in stocks in similar patterns to their investments in Forex. Currencies are driven by large market makers, just like stocks.
Getting a heads-up on large trader sentiment gives you a bit of leg-up when it comes to predicting where the market is going. It’s especially useful in the majors, where there is lots of regular investment and movement from large funds. Taking a look at net shorts/longs is a good place to get a feel for market sentiment. But there are also more sophisticated indicators.
Something similar to what Chu pointed out on Bloomberg is what David Rodriguez has been saying for quite some time, while promoting SSI over at dailyfx.com While most traders focus on fundamental versus technical analysis, there is a third component which is often forgotten: sentiment analysis. Of course, you could technically say that’s also technical analysis, but it’s worth considering separetly.
Small traders like us don’t make the market, so we should at least aknowlege that our trading strategy is partly based on following what other, bigger traders do. They are far from perfect, often reacting to news hastilly or making superficial decisions that the fundamentals don’t warrant.
It’s possible that you could make the best decision about what the market should do given technical and fundamental indicators, but market sentiment just doesn’t feel that way. The bottom line is, the market is going to go where it wants to, which isn’t always what’s best for the market. A good trader knows where the market will go, not necessarily where the market should go.