Identify patterns and spot market bubbles using Heckyl Sentiment Index

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In today’s global economy, stock market bubbles are a part of life. Bubbles now inflate and deflate much more often than in the past. Free flow of money across markets and wider dissemination of information are partly responsible for formation of bubbles. It is created when the surge in asset price is not justified by its fundamentals. It burst with collapse in asset price when market sentiment turns.

Bubbles in the stock market are difficult to spot. So it is important for traders and investors to understand them to avoid being caught in a bubble. By leveraging the vast amount of news on the internet and applying sophisticated analytics, they can get collective sentiment about companies and market.

nifty-sentiment-chart

Heckyl has introduced Sentiment index to gauge perceptions about the Indian stock markets. Sentiment Index leverages Heckyl’s news and sentiment analysis capabilities. Heckyl distills massive amounts of news data and then analyses its potential impact on the stock prices in real-time.

Sentiment index reflects a broad reading of collective sentiment for the Nifty companies. Traders and investors can use sentiment index as a directional signal to identify patterns and market bubbles.

We have back tested 4-years’ data from February 2013 to January 2017 to find out whether Sentiment Index is a better indicator for the Nifty or not. We have used 30-day and 90-day averages of Sentiment index and the Nifty values in our study.

By looking at above chart, one can see that when short-term sentiment (30-DMA) rises, it tends to pull up Nifty index higher. On the contrary, when short-term sentiment (30-DMA) falls, Nifty index tend to follow it down.

Bullish Signal:
When short-term Sentiment (30-day average) rises above long-term (90-day average), green shading indicates likely uptrend for the Nifty.

Bearish Signal:
When short-term Sentiment (30-day average) falls beneath long-term (90-day average), pink shading indicates likely downtrend for the Nifty.

Trend Reversal:
Extreme optimism and pessimism can give early warning about trend reversal and market bubble. On many occasions, downtrend for the Nifty started when sentiment moved into extremely bullish territory (highlighted in the chart). We also noticed uptrend for the Nifty when sentiment moved into extremely bearish zone.

Key Observations:
Correlation between Sentiment 90-day average and the Nifty stood at 0.85 for the past 4-years, indicating a strong uphill relationship [Correlation value lies in between +1 (perfect positive) and –1 (perfect negative)]. Meanwhile, correlation between Sentiment 30-day average and Nifty Index was 0.71, signaling a strong positive relationship. It is evident from such a high level of correlation that Heckyl Sentiment index is a better indicator for the Nifty.

The Bottom-line:
Heckyl Sentiment Index is very useful tool to quantify bullish and bearish sentiment for the Nifty. By tracking our Sentiment Index, traders and investors can not only identify patterns, but also spot the next bubble for the Indian markets.

This article was first published in March – 2017 edition of BSE Brokers Forum Magazine.

To know more, email us at info@heckyl.com

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