What is Trader Sentiment?
In the financial world, investor or trader sentiment is a way to understand the bullishness or bearishness of market participants.
Sentiment indicators should never be used in isolation, but always together with the tools of technical analysis. At the same time, sentiment indicators can provide chartists the “icing on the cake” and enable them to make excellent predictions in financial markets.
We see two ground rules for the use of sentiment indicators:
- Rule 1: Turning points can be accompanied by massively skewed trader sentiment, with extreme bullishness observed at market tops and extreme bearishness at market lows.
- Rule 2: When sentiment moves from bearishness (negative values) to bullishness (positive values), this could mean strong upside (and vice versa). Sentiment is not always a contrarian indicator, because sentiment can remain at elevated (bullish) or depressed (bearish) levels for a very long time.
Bottling Bitcoin Sentiment: The “Bitcoin Bull Bear Index ©” (BBBI)
Bitcoinullbear.com has been measuring sentiment through a running poll of site visitors:
What do you expect BTC/USD prices to do in the next 4 weeks?
- Same as now
- I do not know
The data derived from this informal poll is first transformed into the BBBI index and then compared to actual bitcoin price development. Lastly, we create a specific bitcoin chart like the one below which contains the most recent Bitcoin Bull Bear Index (red line) and Bitcoin prices (blue line) from today (click image to enlarge).
The predictive value of the Bitcoin Bull Bear Index is compelling.
In April 2011, the BBBI exceeded 50 for the first time and this was the starting point of a huge bitcoin price rally from 0.58 $ to 31.9 $ in June 2011. This was a whopping +5,402 % rally. This is a good example that when sentiment gets very bullish, there is typically much more upside: Rule 2.
The BBBI made a new low of -40 on August 7, 2011 when bitcoin prices were at 7.72 $. Since then, this indicator never moved below -40 anymore, despite the fact that bitcoin prices fell another -5.7 $ (-74%) to 1.994 $. Again, this is a good example of Rule 2: sentiment turned very bearish and kicked off more downside.
Now to examples of Rule 1:
After a massive rally, people interested in bitcoins got so euphoric that the BBBI indicator reached 81 on June 5, 2011. At this time, we called an impending top in our subscriber section and on June 8, 2011, bitcoin prices topped at 31.9 $. The sentiment was the “icing on the cake” for us to warn subscribers about a major sell off that was indeed happening (and which eventually fell more than -90% ).
In the last stages of the very strong bitcoin price decline over October and November 2011, our indicators showed that bitcoin sentiment was no longer trending bearish. Instead, the BBBI indicator diverged against bitcoin prices. This diverging behavior can be seen often in down markets and it showed us that very likely they will not be a decline below $2 in the near term. Coupled with other indicators we use in the bitcoin analysis, this is why we called out for a potential major bitcoin price reversal.
BITCOIN WEATHER FORECAST
Since last week, I turned at least into a short term “BITBULL in the SUN” again, as priced indeed broke out and surpassed the $2.8 and even $3 level. Since then, also the bitcoin sentiment has turned around strongly, to a BBBI value of 57 over last week. This could very well be the kick off to a sustained rally (Rule 2), possibly to new highs above $32 in 2012.
Currently, bitcoin prices are consolidating from this latest huge rally (+57% in 10 days), which is normal. Further upside is likely, as long as we don’t get a “bitcoin thunderstorm”: A decline through $2.4 would raise dark clouds on the bitcoin horizon and a break below $2 could push bitcoin prices down into the low $1 zone.