Wednesday, November 7, 2007

Market Sentiment Oscillator

Earlier this fall, Dr. Brett Steenbarger of TraderFeed published an excellent series of articles outlining three market sentiment indicators based on inter-market ratios. The articles presenting the rational follow:

Gold as a Sentiment Measure for Technology

Using Sector Relationships to Catch Trader Sentiment

Global Performance as a Gauge of Trader Psychology

Intrigued and inspired by the good doctor, I developed a simple unified sentiment oscillator and trading system incorporating the core concepts from these three posts, plus an additional ratio relating the Dow Transports to the S&P500. The oscillator is calculated by adding the log ratios of EEM:SPY, XLK:^XAU, XLY:XLP, and IYT:SPY. A ten-day ratio of the result converts the calculation to an oscillator.

You will find that the oscillator moves fairly consistently between 0.99 and 1.01, which indicate short-term market despair and euphoria, respectively. Today's ugly market pushed this indicator down to .994. In my next post I will suggest a hypothetical trading system that employs this oscillator.

2 comments:

coasternuts said...

I'm trying to understand this calculation. Could you clarify:

log_sum = ln(EEM/SPY) + ln(XLK/^XAU) + ln(XLY/XLP) + ln(IYT/SPY)

Ten day ratio = ?

Jeff Pietsch CFA, Esq said...

Hi Coasternuts,

A = ln(eem)/ln(spy) + ...
B = A / A(10)

Best, Jeff