Presenting the third article in Tickertape Feature Series.
“Be fearful when others are greedy and greedy when others are fearful” is something that the followers of Warren Buffet practice religiously. Emotions play a vital role in stock investing. When in check and coupled with logic, we tend to make better investing decisions compared to when we act based on emotions solely.
Among others, entry and exit points are two important decisions to make when investing in stocks. In fact, new investors are often troubled with questions regarding when to buy and sell stocks. That’s why, we built the Market Mood Index, a tool that can help you time your investments better.
MMI and market sentiment
MMI tracks the market sentiment, the attitude of investors towards the overall stock market or a specific stock. The analysis of this sentiment works on the lines of the law of demand and supply. Keeping the supply constant, when the demand for a commodity rises, its price also increases. But when the demand decreases, the price falls.
Stock prices are heavily driven by two emotions, namely greed and fear. And the MMI puts out the market sentiment in 4 emotional zones: Extreme Fear, Fear, Greed, and Extreme Greed. A positive outlook on the market or a stock makes investors greedy and drives them to buy more stocks, which shoots the prices. Fear, on the other hand, is the outcome of bad news. This forces investors to sell stocks and thus brings down the prices.
Such an analysis of investor sentiment is considered to be one of the most reliable methods to time the entry and exit points in stock investing. The entry point means when you buy a stock and the exit point is when you sell it. That said, selling price minus buying price is profit or loss. Ergo, smart plotting of entry and exit points is crucial to streamline your investment plan.
Now that you have understood what market sentiment and MMI are, let us look at its 4 zones.
The 4 Zones of Market Mood Index
- Extreme Fear
- Extreme Greed
Extreme Fear Zone: index less than 20
This zone indicates that the market is suffering and so many investors are liquidating their stocks. An oversold market is a good time to buy stocks as they may be available at cheaper prices.
Fear Zone: index ranges between 30 and 50
This zone shows that the market is reeling but based on the MMI trajectory, you can infer whether the market is doing better or worse. Trajectory means the trend that the MMI follows. If the MMI is in Fear Zone and an economic development further dampens investor sentiment, then the market can slip further down, pushing the MMI into Extreme Fear Zone.
For instance, if you remember the stock market rallied when there was news of COVID-19 cases decreasing globally. This news boosted investor sentiment. And so, depending on further developments, the trajectory at the time, the MMI may have either moved from:
- Fear Zone to Extreme Fear Zone
- Fear Zone to Greed Zone
So when in the Fear Zone, it is best to wait till the MMI jumps to the Greed Zone before selling your stocks. But if the Fear Zone moves to Extreme Fear Zone and you’re afraid that the way forward is even worse, you could sell your stocks to stop your losses.
Greed Zone: index ranges from 50 to 70
This zone suggests that the market is doing well and as a result, investors are greedy. When the MMI is in this zone, the market is said to be in the overbought area. Like when in the Fear Zone, here also it is good to watch the MMI trajectory before entering or exiting the market.
Let us understand the mechanism with an example. Whenever COVID-19 cases rose after dipping for a bit, investors turned extremely cautious and liquidated their stocks. In this case, there are two possible trajectories of the MMI, depending on its current zone:
- Greed Zone to Extreme Greed Zone
- Greed Zone to Fear Zone
If the MMI is in Greed Zone, it is best to wait till it falls into the Fear or Extreme Fear Zone before buying stocks. But if the MMI moves to Extreme Greed Zone, it indicates that the market is in overbought zone and stocks are expensive. Ergo, buying new stocks is best postponed.
Extreme Greed Zone: index is over 70
This zone suggests that the stock market is extremely overbought. A good thing to do in this case is to wait for the market to stabilise before buying new stocks.
Now let us see how the Market Mood Index is built.
How is Market Mood Index built?
The MMI tool is built based on the 6 fundamental factors that influence investor sentiment:
- FII Activity
- Volatility & Skew
- Market Momentum
- Market Breadth
- Price Strength
- Demand for Gold
Let us look at these individually.
FII Activity in India
FII stands for Foreign Institutional Investors, international companies that invest in Indian stock markets. Markets perform well when the inflow of FIIs is more than the outflow. In other words, higher FII brings more funds to the economy and so boosts investor sentiment. At such a time, the MMI is in the Greed Zone. But when there is an exodus of FIIs from domestic markets, investor sentiment dampens and MMI in the Fear zone.
Volatility and Skew
The market is said to be volatile if benchmark indices fluctuate frequently. One of the ways to measure volatility is the India VIX index, which indicates the market volatility expected to prevail over the next 30 calendar days. Higher the VIX index, higher is the volatility in the stock market. But knowing the direction of volatility is equally important to analyse markets better.
Enter Skew, which shows the direction in which the market is expected to move. A high average value of Skew indicates that the market could move downwards. In terms of MMI, a higher value of Skew suggests that the MMI would slide into the Fear Zones whereas, a lower Skew suggests that the MMI would move into Greed Zones.
In stock markets, Momentum indicates the movement of the market or stock from a current point. Momentum can be calculated using various methods including the exponential moving averages of Nifty. A positive exponential moving average indicates a bull market. Ergo, the MMI enters Greed Zones. In contrast, a negative exponential moving average signifies a bear market and as a result, the MMI slides into Fear Zones.
Market Breadth tracks the number of stocks moving upwards compared to those that are declining. If more number of stocks are moving upwards instead of downwards, market breadth is said to be positive. This indicates that the broader market is performing well. Negative market breadth is when the more stocks are moving downwards, which suggests that the broader markets and economy are suffering. Market Breadth is calculated using the Modified Arms Index; lower the index stronger the market and vice versa.
This measures how strongly a stock market is heading towards a bullish or a bearish direction. The difference between % of stocks that near their 52-week low and the % of stocks near their 52-week high is the price strength. A positive or high price strength means a bullish market and a negative or low price strength signifies a bearish market.
Demand for Gold
Higher demand for gold signifies that investors are wary of entering stock markets, pushing the MMI into Fear Zones. In contrast, lower demand for gold indicates that the stock markets are faring relatively well, pushing the MMI into Greed Zones.
MMI is 93.75% accurate
We take delight in the fact that MMI has been back-tested and found to be 93.75% accurate in predicting market top- and bottom-outs. So why not start using MMI to empower your investments? While the MMI is for free, you will need to upgrade to Tickertape Pro membership to download historical MMI trajectory for a deeper stock market analysis.
Finally, note that MMI is not a trade recommendation tool but only a device to aid in better timing the market. Sign up today to explore the MMI, Tickertape’s loved feature 🙂