Using investor sentiment in my investing decisions

October 15, 2008

Yesterday’s rally was great. But it did not last. It could not. The actions the government took so far were purely about investor sentiment. The goal for these actions were to stop the fear, the anti-bubble (is this called a maelstrom or what?) It was necessary to prevent greater harm.

However, these actions have done nothing to add value to the economy and cannot stop a downturn caused by systemic problems. Hence, every rally will be short-lived and the markets will continue to fall until they reach the true market potential. As markets fall, demand for products and services fall.

When demand softens, companies have to cut costs to balance income statements. This is usually done through layoffs, which will help individual companies but further decrease overall market demand for goods and services.

Strong companies have war chests for such situations. They can invest in R&D, invest in the future and position themselves for the moment when demand returns. These companies will be market leaders after the shakeout.

As a long-term investor, I need to find companies that show this strength potential. I will look for companies that are streamlining operations and expanding/maintaining their expenditures into R&D.

I will also look for companies with relatively stable sentiment trends on www.predictwallstreet.com. A stable sentiment tells me that the price is most likely driven by a company’s market performance rather than psychology. For example, investor sentiment for Johnson and Johnson (JNJ) is stable on the 3-month sentiment chart.

Investor sentiment for JNJ

As a short-term trader, I can take advantage of the market fluctuations caused by investor sentiment. Again, I use the sentiment meter and sentiment charts on www.predictwallstreet.com to see which direction the wind is blowing. Right now, PredictWallStreet has 746 predictions on the Dow Jones Industrial Average (DJIA) showing that investor sentiment is extremely bearish.

Investor sentiment for DJIA

Over the last 3 month, investor sentiment for Apple (AAPL) varied a lot. I see that sentiment was in the extremely bearish zone several times but very few times in the bullish zone. The blue line shows a price that is mostly decreasing.