Market Sentiment in Stock Indices 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 couple of things, among the common ones are:
- Economic Outlook and Economic data reports
- Monetary Policies – Such as Interest Rates and Inflation policies such as Quantitative Easing
Short Term Market Sentiment – Economic Outlook and Economic Data Reports
Some of these factors will affect the short term market sentiment meaning they will only cause some minor volatility in the market which 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 may show that the unemployment rate went higher by about 1 % which in the short term may cause the EURO STOXX index to pullback because of this short term volatility, but because other EU Zone economic reports have been showing positive data that provide evidence of economic growth in the EU, the 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 volatility. The volatility may move the market in any particular direction in the short term, but what matters most is the Economic Outlook. For example if the market outlook for EU 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 indices.
The two components of monetary policy are: Interest Rates Control and Inflation Control.
These two components determine the economic growth prospects for a country.
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 is cheap to borrow and 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 is not readily available to people to do business with and therefore people have less money to do business.
For this reason those countries with low interest rates mean that the market sentiment when trading the stock index of these countries will be positive as this low interest rate policy encourage economic growth.
Therefore the market sentiment for countries with low interest rates will mean the long market 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 policy is just a factor among many other factors that influence market sentiment.
The monetary policy of any economy will also be formulated to control inflation. The optimum 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 cannot sustain economic growth and a country faces the risk of economic slowdown.
Between 2% and 5% - the prices of goods and services at this inflation levels will be at the optimum levels – meaning the price are high enough to sustain economic growth and at the 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, the higher the inflation level goes the more unaffordable the price of goods and services become, meaning less spending power from the consumers, therefore meaning producers of good will not 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 is not 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 and economic growth slows down, too high and economic growth also slows down, and this is why economies have to aim for the optimum inflation of between 2% and 5% to ensure the economic growth of their economy is bullish.
This is the reason 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 stock index.
Example of Long Term Sentiment Influenced by Monetary Policy
One example of a stock index market move influenced by a monetary policy is the USA stock index market – Dow Jones 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 interest rates.
Quantitative easing policy is a monetary policy aimed getting people to spend and at the same time bring inflation levels up to the optimum levels. When FED started their Quantitative Easing program, the 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 in 2015 policy by raising their interest rates, the market sentiment started to shift and 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 some time. All these market moves being influenced by market sentiment that was being driven by the USA monetary policy.
Another example of monetary policy influencing the market indices was the EU Quantitative easing policy announced 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 and between January and March all European Stock Indices were all up significantly and 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 and 2016, will be the main Factor influencing the long term market of all European based Stock Indices – Such as EURO STOXX, Germany DAX 30, France CAC 40, Italy FTSE MIB 40, Netherlands AEX 25 and Spain IBEX 25 Indices.
For Example, the Germany DAX 30 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 index was poised to keep going up and maintain the bullish momentum for 2015 and 2016 – the length of time that the EU Quantitative easing program is going to run.