Emotional markets can present excellent opportunities for an astute investor. If you can develop strategies that consider these market sentiments, it can provide a lucrative opportunity. Below I'll show you some simple tools you can use to improve your investing outcomes.
The market emotional cycle
The difficulty is that, in hindsight, it's easy to see where the market sentiments are. However, at the moment, it's not possible to accurately predict what the market mood is unless you have additional information that provides a gauge to measure against.
One way to recognise emotion in the market is through pricing metrics. Thankfully there has been some amazing research conducted in this space currentmarketvaluation.com provides some of the best representations of market pricing analysis and is definitely worth a look.
Looking at the stock market in 2000, just before the dot-com bubble crash, we can see that the market was priced extremely high relative to the earnings these companies were making at the time.
Stock Market Fear and greed index
Another great tool that can be used for sentiment analysis of the current market is the CNN Fear and Greed Index. This is useful in that it takes into account a broad range of real-time sentiment indicators, such as options (insurance) purchased because people tend to buy more insurance when they are fearful.
Strategies for investing in emotional markets
Ok, so you may be thinking, well, so what does it matter what the market emotion? How do I protect my investments and grow my portfolio during turbulent times? There are a few strategies you can deploy specifically for this purpose.
If you want to know more about protecting your portfolio during a market downturn, we've discussed managing your risk in our article How to use the Fear and Greed Index to invest in the Stock market.
Contrarian and Value Investing
These investing strategies are similar in that they involve looking for investments that are underpriced by the market.
Although this sounds relatively simple, it can be quite complex and involves looking through many investments to find a single company that meets your criteria. It also involves assessing other company valuation considerations, such as debt and future income analysis.
Some technological advances have made this challenge significantly easier; tools like Simply Wall St and Stockopedia have levelled the playing field more between big hedge funds with limitless research capacity and the everyday investor.
Momentum investing
The idea behind this is that when a certain trend occurs, more individuals will join in, intensifying that trend. Whether it's an exciting rally or a financial collapse, people tend to experience FOMO (fear of missing out) when the market is increasing or to panic when an investment is decreasing.
In Summary
Market sentiment can cause violent swings in your investments; sophisticated investors would consider those movements in their investment decisions and incorporate them into their strategies.
If you'd like to learn more about this topic, we will do a deeper look at these in our free investor BootCamp program. Register your interest now.
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