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Market Sentiment Analysis

Updated: Feb 21

Analyzing market sentiment and knowing whether the trading activity is bullish or bearish on any trading day is challenging for traders and investors.


Unfortunately, many people go with the views of the majority, thinking it will be the right market sentiment. But most people lose money in the stock market, so how can their views be right on the market?


It is always a good idea to track the activities of FIIs, fund managers, investors, and big traders. But the problem is that their actions are not visible, and tricky to decide with the available data.


Hence I came up with my version of ‘market sentiment’ that measures the activities of all these big players from 3 different dimensions. All I need a simple price chart to perform the analysis.


How to calculate Market Sentiment?


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What Is Market Sentiment?


As per Investopedia definition, Market sentiment refers to the overall attitude of investors toward a particular security or financial market. It is the feeling or tone of a market, or its crowd psychology, as revealed through the activity and price movement of the securities traded in that market.


In simple words, market sentiment refers to the overall feeling of the people towards the market. Therefore, understanding the market sentiment allows you to judge whether a market feels optimistic or pessimistic about the future of prices of a stock or index.


It will be positive (bullish) when the market is in an uptrend and negative (bearish) when the market trend is down.



How to Measure Market Sentiment?


All the markets are fueled by emotion, which is one of the main reasons traders can find opportunities to trade. Therefore, successfully identifying and evaluating market sentiment before taking a trade will help traders step back objectively and avoid unnecessary trades. Besides, it also helps in planning a trade in the live market.


Sometimes market sentiment is also recognized as ‘investor sentiment.’ Intraday traders and swing traders rely on price action or technical indicators. In contrast, many investors depend on fundamental factors to arrive at the market sentiment.

The India VIX, The High-Low Index, Gainers/Losers info are valuable indicators to arrive at the market sentiment.


However, I have used a simple price chart and market profile chart (not mandatory) to calculate the market sentiment.



Market Sentiment Analysis


Gauging the market sentiment is the trickiest part of trading, as the market's outlook is shaped by anything and everything.


I will use three essential aspects of the market profile to calculate the market sentiment.


I will explain these three concepts in terms of market profile using a free market profile chart source and describe how to apply the same using a simple candlestick chart.


The three critical aspects which are required to calculate market sentiment are:

  1. Value Area Shift

  2. Range Extension

  3. Extremes

Do you know why I am taking only these three features of the market profile and ignoring the rest?


The answer is pretty simple. These three features measure the smart money/big players' activity from three different dimensions.


‘Value Area shift’ indicates the overall effect of smart money.


‘Range Extension’ indicates the effect of smart money after IB range formation (after 1-hour of the market open).


‘Extreme’ indicates big players’ urgency to grab any good opportunities.


We should do this assessment only after the completion of the trading hours.




Value Area Shift


Image 1 – Value Area in Nifty
Image 1 – Value Area in Nifty

On any trading day, the value area is nothing but a price range where 70% of the day’s business (or 2/3rd of the entire day’s activity) is conducted.


(PS – There is no need to calculate this info. Gocharting provides FREE EOD market profile charts)


In this case, we will compare today’s value area with the previous day's value area.


Image 2 – Value Area Shift (positive)
Image 2 – Value Area Shift (positive)

If today’s value area is moved upside, as compared to the previous day's value area, then we can mark it as ‘positive’ (Image 2).


Image 3 – Value Area Shift (negative)
Image 3 – Value Area Shift (negative)

Else if today’s value area is moved downside, as compared to the previous day value area, then we can mark it as ‘negative’ (Image 3).


Image 4 – Value Area Shift (neutral)
Image 4 – Value Area Shift (neutral)

Otherwise, if today’s value area is the same as the previous day's value area, we mark it as ‘neutral’ (Image 4).


Alternative Technique Through Candlestick Chart

One can also do a similar assessment by looking at the candlestick chart.


Image 5 – Value Area Shift Analysis using candlestick chart
Image 5 – Value Area Shift Analysis using candlestick chart

The above image only contains a candlestick chart, and it doesn’t include the market profile chart.


If you observe, today’s comprehensive range is shifted upside. Hence, the value area shift parameter can be marked as positive.


Similarly, if it is shifted downside, then it can be marked as negative.


Range Extension


There is a famous saying in the market –

“Amateurs open the market, and professionals close the market.”

It means retail traders are eager to trade every day and hence participate quickly when the market opens.


However, experts wait for some time, observe the market, and then make calculated moves.


The market profile also uses the same concept with the definition of Range Extension (RE). It is nothing but a movement of price outside the first 1-hour range.

RE is always created by big players who can give the magnitude and direction.


Image 6 – Range Extension (positive)
Image 6 – Range Extension (positive)

If the range extended on the upside, then we can mark it as ‘positive’ (image 6).


Image 7 – Range Extension (negative)
Image 7 – Range Extension (negative)

If the range is extended on the downside, then we can mark it as ‘negative’ (image 7).


Image 8 – Range Extension (neutral)
Image 8 – Range Extension (neutral)

In case no range extension on either side, we can mark this parameter as ‘neutral’ (image 8).


Similarly, we mark this parameter as ‘neutral’ in case of equal range extension on both sides of the 1-hour range.


Alternative Technique Through Candlestick Chart

Again we can assess this parameter by looking at the candlestick chart. Opt for a 15-min or 30-min timeframe candlestick chart and mark 1-hour range.


Then check whether the price has moved upside or downside to mark this parameter.


Image 9 – Range Extension Analysis using candlestick chart
Image 9 – Range Extension Analysis using candlestick chart

Extremes

Extremes are nothing but single prints at the top or bottom of the profile. For example, in the candlestick chart, big buying wicks or selling wicks represents extremes.


Image 10 – Extreme (positive)
Image 10 – Extreme (positive)

If the price profile shows a buying extreme, then we can mark this parameter as ‘positive’ (image 10).


Image 11 – Extreme (negative)
Image 11 – Extreme (negative)

If the price profile shows a selling extreme, then we can mark this parameter as ‘negative’ (image 11).


Image 12 – Extreme (neutral)
Image 12 – Extreme (neutral)

If the price profile doesn’t show any extreme or shows equal extreme on both sides, we can mark this parameter as ‘neutral’ (image 12).


Alternative Technique Through Candlestick Chart

Again we can assess this parameter by looking at the candlestick chart.


Opt for a 15-min or 30-min timeframe candlestick chart. Then check whether any price candles have displayed any big buying or selling wick near day’s high or day’s low to mark this parameter.


Image 13 – Extreme Analysis using candlestick chart
Image 13 – Extreme Analysis using candlestick chart

Please note it is not a completely accurate method as sometimes, a candle may not show a big wick, but there is an extreme in the market profile chart.




Market Sentiment Example-1

Please note that we should do this assessment only after completing market hours (as we get the complete data).


Image 14 – Market Sentiment Example-1
Image 14 – Market Sentiment Example-1

The image-14 shows an example.


As compared to the previous day value area, today’s value area is shifted upside. Hence VA Shift parameter is positive.


Range extended above 1-hour range, hence Range Extension parameter is positive.


There are no single prints at the top and bottom of the profile. Hence, the Extreme parameter is neutral.


Hence, the Market Sentiment (MS) is positive for the next day. So, traders can look for long trades on the next day.



Market Sentiment Example-2

Image 15 – Market Sentiment Example-2
Image 15 – Market Sentiment Example-2

The image-15 shows another example.


As compared to the previous day value area, today’s value area is shifted downside. Hence VA Shift parameter is negative.


Range extended below 1-hour range, hence Range Extension parameter is negative.


There are extremes present in the top and bottom, and hence, the Extreme parameter is neutral.


Hence, the Market Sentiment (MS) is negative for the next day. So, traders can look for short trades on the next day.



Market Sentiment Example-3

Image 16 – Market Sentiment Example-3
Image 16 – Market Sentiment Example-3

The image-16 shows another example.


As compared to the previous day value area, today’s value area is shifted upside. Hence VA Shift parameter is positive.


Range extended below 1-hour range, hence Range Extension parameter is negative.


There are no extremes present at the top and bottom, and hence, the Extreme parameter is neutral.


Hence, the Market Sentiment (MS) is neutral for the next day. It indicates indecision. Therefore, traders can wait for any further confirmation on the next day.




How to Trade Using Market Sentiment?


Estimating the market sentiment is one aspect, but trading it is another aspect.


Always remember there is a big difference between how the market feels today at the market close and how it feels tomorrow at market open.


Besides, Market sentiment is just a tool to analyze the market's overall sentiment and understand what big players are doing to prepare yourself for subsequent day trading.


Traders must apply some sort of confirmation from the market to manage their trades. Below are some of the examples:

  1. MS is positive, and tomorrow the price shows open-low in 15-min chart above the previous day range. Then a trader can plan a long trade.

  2. MS is negative, and tomorrow the price shows open-high in the 15-min chart below the previous day range. Then a trader can plan a short trade.

  3. MS is positive, and tomorrow price showed rejection at the previous day low and also formed bullish engulfing in 15-min chart. Then a trader can plan a long trade.


Market Sentiment analysis works wonderfully with stocks as compared to indices. Because only the limited people participate in stocks on any particular trading day, but there is always a chance of new players entering the market for an index.



Market Mood Index


ET Now and smallcase came up with the idea of market mood index, which shows the overall market sentiment.


Image 17 – Market Mood Index

It uses many parameters like FII data, volatility, price strength, market breadth, momentum, demand for gold, etc., to calculate the readings of the MMI.



Conclusion

This is a simple example of using market profile concepts to arrive at the market sentiment.

But the market profile is a vast concept and it is highly beneficial for intraday traders.

One can take up my online course "Intraday Trading Through Market Profile" or read my book "Mind Markets and Money" to know more about Market Profile.



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