What will the market do next?
There are many indicators, and about as many interpretations of those indicators, investors use in an attempt to predict the market's next move. While some, if applied correctly, have a respectable track record, few indicators are as reliable as investor sentiment.
The irony behind this trusty gauge is that it fools investors into buying or selling at just about the worst time. Since investor sentiment surveys reflect the mood of the very investors who are trying to be a step ahead, it is a contrarian indicator. Why? Because market participants become more optimistic as stock prices rise and more pessimistic as stock prices decline. That's why market tops are accompanied by some degree of euphoria over stocks while market bottoms coincide with a doomsday-like atmosphere.
This interesting phenomenon is easily explained. Extreme bullishness becomes a problem for the bulls as an extended run for stocks increases the base of stock owners. At a market top, people wanting to own stocks will have converted from wanna-be buyers to owners. At that point, the pipeline of new buyers has dried up to a point where there's simply not enough buying volume to drive up prices any further.
This is compounded by the fact that owners are reduced to either holding or selling, neither of which can propel prices. As the base of stock owners has become unproportionally high, the cycle reverses. Inevitably some owners give in and start selling. As prices start to decline, more stocks are being sold and selling becomes the new trend. The unusual high level of stock ownership provides a consistent flow of stocks being put up for sale, resulting in rapidly declining prices.
