Market Sentiment in Index Trading

One of the factors that influence stock index movement is the prevailing market sentiments at any particular moment. The market sentiment is determined by a few things, among the common ones are:

Economic Outlook and Economic data reports
Monetary Policies - Such as Interest Rates and Inflation policies like Quantitative Easing

Short Term Market Sentiment - Economic Outlook and Economic Data Reports

Some of these factors will affect the shortterm market sentiment meaning they will only cause some minor volatility in the market that will only take a few hours or day to fade out. These short-term market sentiments are best utilized by trader to look for the best entry points for opening trades.

For example an economic report about unemployment rate in the EU zone might show the unemployment rate went higher by about 1 % which in the short term might cause the EURO STOXX index to pull back due to this short term volatility, but because other EU European Union Zone economic reports have been showing positive info that provides evidence of economic growth in the EU Zone, EURO STOXX index will resume its upward trend direction soon after this short term volatility.

Most economic data reports will mostly cause this type of short-term market price volatility. The volatility might move the market in any particular direction in the short-term, but what matters most is the Economic Outlook. For illustration if the market outlook for EU European Union Zone is positive economic growth, then the general direction of the EU based indices will be upwards despite the short term market volatility caused by economic data reports.

Long term Market Sentiment - Monetary Policy

Apart from the economic outlook of a particular economy which is the main factor that determines the long term market sentiment for a particular index, monetary policy is the other factor that determines the long term market sentiment of stock indices.

The 2 components of monetary policy are: Interest Rates Control & Inflation Control.

These 2 components determine the economic growth prospects for a country.

Interest Rates

Interest Rates determine the amount of credit available to people for doing business and the cost of this credit. Those countries with interest rate of 1% mean that it is very cheap to get credit in these countries and in general people can borrow more money, because it's cheap to borrow & these people can then do more business as they have more capital. If on the other hand a country has an interest rate of 10% will mean that credit isn't readily available to people to do business with & therefore people have less money to do business.

For this explanation those countries with low interest rates mean that the market sentiment when trading the of these countries will be positive as this low interest rate policy encourage economic growth.

Therefore the market sentiment for countries that have low interest rates levels will mean that the long term sentiment for these economies will be bullish.

However, a country with a good economic outlook and high interest rate policy will still have a bullish market sentiment. The low interest rate monetary policy is just one factor among many other factors which influence market sentiment.

Inflation Policy

The monetary policy of any economy will also be formulated to control inflation. The optimum ideal inflation level is between 2 % to 5 %.

Below 2 % a country will go into deflation, where prices of items start to drop to levels which can not sustain economic growth & a country faces the risk of economic slowdown.

Between 2% & 5% - meaning the price are high enough to sustain economic growth & at same time these prices are not too expensive to make the goods and services unaffordable to the consumers.

Above 6% - prices are starting to get expensive and becoming out of reach of consumers in terms of affordability, higher the inflation level goes the more unaffordable the price of goods and services become, meaning less spending power from consumers, therefore meaning producers of good won't make enough sales and profits as the price of their goods is out of reach for the consumers because they have become too expensive and unaffordable. This isn't good for economic growth, in fact this will also cause economic slowdown because goods are not moving as fast within an economy.

The art of inflation control is a delicate balancing act, too low & economic growth slows down, too high and economic growth also slows down, & this is why economies have to aim for the optimum inflation of between 2% & 5% to ensure the economic growth of their economy is bullish.

This is the reason/explanation why the long-term market sentiment will be determined by the inflation control policy.

As a stocks trader you may not be aware of a country's monetary policy, but these policies are the main factors that determine the long term market sentiments of a particular index.

Example of Long Term Sentiment Influenced by Monetary Policy

One example of a market move influenced by a monetary policy is the USA market - Dow Jones stock index which moved from 10,000 points up to 18,000 point influenced by Quantitative Easing Policy implemented by the FED after they had also take the monetary policy of reducing/decreasing interest rates.

Quantitative easing policy is a monetary policy aimed getting people to spend and at same time bring inflation levels up to the optimum levels. When FED started their Quantitative Easing program, American Stock indices all went up based on this market sentiment - an example is the Dow Jones index that went up from 10,000 point to 18,000 point.

At the same time when FED started proposing change to their monetary policy in 2015 policy by raising their interest rates levels, market sentiment started to shift & stock index started to take a break from the continued upward trend. The upward trend soon resumed after the prevailing monetary sentiment resumed after this speculation of interest rates hike was shelved for a while. All these market moves being influenced by market sentiment that was being driven and pushed by the USA monetary policy.

Another example of monetary policy influencing the market stock indices was the EU Quantitative easing policy and program announced/implemented in January 2015 after a series of EU interest rates reduction. Because of this policy the long term market sentiment for EU indices changed to bullish & between January & March all European Index were all up significantly & poised to continue this upward trend even after the QE program was started in March.

Now this EU Quantitative Easing Policy which is to be carried throughout 2015 & 2016, will be the main Factor influencing the long term market of all European based Indices - Such as EURO STOXX, Germany DAX30, France CAC40, Italy FTSE MIB 40, Netherlands AEX 25 & Spain IBEX 25 Index.

For Example, Germany DAX30 went up by 22,000 Points between January 2015 when this QE policy was announced and March 2015 when this program was started - with the long term market sentiment showing that this stock index was poised to keep going up & maintain the bullish momentum for 2015 & 2016

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