How to gauge market sentiment using technical analysis techniques

Sentiment is the overall view of market participants about a particular stock or the market as a whole. It is an integral part of the stock market, and a clarity about sentiments helps investors build a broad view of the possible future trend: positive sentiment suggests a bullish outlook, while negative sentiment points at a bearish one.

Whenever majority favours a particular sentiment, it is said that the trend and direction are highly robust. The sideways movement of stocks indicates a confused/ mixed sentiment and sooner or later market participants are expected to take a directional view.

Generally, trading in line with the direction of the market sentiment is considered a safer approach, since the risk-return ratio is more favourable. Few traders even opt to add or average stocks at higher levels, citing strong market sentiment.

Why understand market sentiment?

-- Day traders favour the trend supported by firm sentiment in order to make quick gains

-- Short traders are expected to liquidate positions as standing against the market sentiment may result in grave losses

-- Investors prefer trending markets with an overall sentiment in bullish direction, since it mitigates risk

-- Volume plays an important role in stock market and add more strength to an already firm sentiment

-- Volatility is low during directional sentiment.

-- Long-term investors can enjoy phenomenal returns if they are able to identify initial stages of a market sentiment cycle.

Indicators to measure market sentiment

The three major indicators of market sentiment are Moving Averages, Technical Indicators, and Candlestick patterns. These indicators show prior signals of a trend acquiring firm sentiment.

Moving averages

The major moving averages are 50-day moving average (DMA), 100-DMA, and 200-DMA. Whenever small averages converge with a larger moving average, the market sentiment is recognized as bullish and vice-versa. These indicators provide outlook on the overall price scenario for the respective trading session, while also assisting in identifying the participation of market players. Investors consider stocks trading above 200-DMA as exhibiting an upward bias.

Technical indicators

Technical indicators like Relative Strength Index (RSI), Moving Average Convergence Divergence (MACD), Stochastic, etc. facilitate in identifying the market sentiment. A firm confirmation of these indicators develops confidence and provides confirmation. Whenever the market sentiment is on the verge of turnaround, these indicators also reflect the shift in sentiment.

Candlestick patterns

A strong bullish candle with a larger body clearly indicates a bullish market sentiment and vice versa. Various patterns like morning star, evening star, bullish engulfing and bearish engulfing reflect certain market sentiments. A strong reversal candle, supported by increased volumes, indicates that the market sentiment is changing from negative to positive. CLICK HERE FOR THE CHART