Determining Stock Market Sentiment

Bonanza C., a member of The Bull Trader Forums, and the blogger at the Yale Short-Term Trading Group, wrote in with his thoughts on market sentiment. He points out a lot of good concepts you should employ to improve your trading system.

"As an investor, you should always be looking to minimize your risk and maximize your returns. For a short-term trader, one way of reducing risk is determining the overall market sentiment in the short-run and trading with the crowd. Three out of every four stocks will be up when the indices are up, and three out of every four will be down when the indices are down (don't ask me where I got these numbers, it's just a saying I've heard). Even if the numbers aren't right, you can't argue with the fact that the majority of stocks will be up when the indices are up, and vice versa. Therefore, determining the overall market sentiment will drastically reduce your risk and increase your chances of entering a successful trade.

Another way of decreasing risk is determing the trend of an industry. You'll increase your odds even more by getting into a company in an industry that has been performing extremely well in a bull market. A good example of this are the commodities that were on an incredible rise in the beginning of the year. If you were able to notice the sharp rise of industries such as gold, silver, and steel, you're probably a very rich man right now (unless of course you held on through the commodities drop in the last month).

Finally, you can decrease your risk even further by finding the leading stocks in hot industries in a bull market. These are stocks that are hitting 52-week highs and are in strong upward trends. There is always the chance of the stock finding a top and reversing, but as many swing traders say, you should "buy high and sell higher". If you look at Apple in the last 5 years, you'll notice that its upward trend was largely undisturbed for the last two years, with just a small hiccup in early 2005.

If you follow these steps, you'll drastically reduce your risk while increasing your return. Currently, I'm largely short in this bear market. Personally, I see no reason to go long on stocks with the Fed hike looming, even if the stock looks promising. If you can trade with the crowd, you'll be able to protect your hard-earned gains, perhaps even build on them."

 -Bonanza