The sentiment trading strategies are connected with traders’ behavior. Investors can use sentiment indicators to gain insight into the stock market’s mood. Volatility based on VIX is one such forward-looking variable indicating participants’ fears and, therefore, could have a forecasting ability. The next one, hedging pressure variable indicates the current hedging needs for market participants, which also has forecasting value. Another one, the Michigan Consumer Sentiment Index is an important consumer confidence index that the University of Michigan publishes monthly (500 telephone interviews are conducted of a contiguous United States sample, 50 core questions are asked, the main benefit is a better understanding of changes in the national economy).
As an example of sentiment-driven strategies, we can recommend an academic paper written by Lee, (When do Value Stocks Outperform Growth Stocks? Investor Sentiment and Equity Style Rotation Strategies) in which they investigate a relationship between investor sentiment and performance of value stocks over growth stocks. To measure noise investors’ sentiment, they use gauges: the CBOE equity put-call ratio and the VIX index. They found that value stocks tend to outperform growth stocks when the CBOE equity put-call ratio is relatively low, or the VIX is relatively high. When the put-call ratio is relatively high, or the VIX is relatively low, however, growth stocks marginally outperform or perform as well as value stocks. Their finding suggests that the return premium of value stocks over growth stocks is at least partially influenced by investor sentiment.
In conclusion, sentiment indicators can be used by investors to see how optimistic or pessimistic people are about the economic conditions or current market. For more sentiment trading strategies, please check our list at: