INDICATORS
Sentimental Implications
Market Sentiment Extremes
by John Jagerson & S. Wade Hansen
The ability to pick up on and properly interpret minute
signals in the market dictates the distinction between success and failure.
Here's how implied volatility can help.
Small vibrations - a large investor begins
buying calls. Virtually imperceptible movements - a hedge fund manager
raises his stop-loss levels. These are telltale signs a change is coming.
The ability to pick up on and properly interpret these minute signals means
the difference between success and failure in the marketplace. Bulls and
bears alike push market sentiment to extremes. Whether the imbalance is
positive or negative, the market must eventually turn and correct itself.
But before it does, it will often announce its intentions through implied
volatility.
IMPLIED VOLATILITY
Implied volatility is an estimate of future price changes. While historical
volatility is an easily quantifiable measurement of past price movement,
implied volatility is an emotionally based guess determined by investors
as they buy and sell options. Implied volatility, or investor fear, increases
as investors become bearish toward the market and decreases as investors
become more bullish. As subjective as implied volatility may be, however,
it is an extremely accurate measurement of the posture of those who drive
the market.
WHY IMPLIED VOLATILITY?
Investors utilize myriad methods to identify and measure levels of market
sentiment. These methods fall into two broad categories: technical indicators
and surveys.
Technical indicators, such as George Lane's stochastic indicator and
J. Welles Wilder's relative strength index (RSI), distill price and volume
information through a mathematical filter to remove the noise - erratic
volatility - from the market. Technical indicators are appealing because
they calculate their results based on objective data.
Surveys are indicators derived from personal responses from active and/or
institutional traders to a series of questions. Surveys are more subjective
than technical indicators, but they still provide an excellent outlook
for the longer-term perceptions of market movers.
...Continued in the March issue of Technical Analysis
of STOCKS & COMMODITIES
Excerpted from an article originally published in the March 2005
issue of Technical Analysis of STOCKS & COMMODITIES magazine. All rights
reserved. © Copyright 2005, Technical Analysis, Inc.
Return to March 2005 Contents
