Market Sentiment in Index Trading

Market sentiment drives stock index changes. It stems from factors like these common ones.

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

Short-Term Market Views from Economic Reports

Some of these things will change how the market feels for a short time, causing small ups and downs that disappear within hours or a day. Traders can use these short-term market feelings to find good times to start new 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 may 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 upwards market trend direction soon after this short term volatility.

Economic reports often spark quick price swings. These moves can go any way short-term. But the big picture matters more: the economic outlook. For instance, positive growth views for the EU mean indexes trend up overall. Short-term jolts from data won't change that.

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 stock market index, monetary policy is the other factor which also determines the long-term market sentiment of a stock index.

The two elements of monetary policy are: Interest Rate Control and Inflation Management.

These 2 components determine the economic expansion 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 individuals 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 the purpose of this explanation, nations maintaining low interest rates are perceived to foster positive market sentiment in their respective trading environments, as this lower rate policy stimulates broader economic expansion.

So, if a country's interest rates are low, people will generally think that the country's economy will do well over the long run.

Nevertheless, a nation demonstrating a positive economic outlook coupled with elevated interest rates will still typically exhibit bullish market sentiment. A monetary policy characterized by low interest rates constitutes merely one of several elements influencing overall market sentiment.

Inflation Policy

Every economy's monetary policy aims to keep inflation in check. The sweet spot for inflation usually sits between 2% and 5%.

Below 2%, a country enters deflation. Prices drop to levels that hurt growth. This risks economic slowdown.

A range of 2% to 5% indicates a price level that supports economic growth while remaining affordable enough for consumers to maintain access to goods and services.

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 aren't moving as fast within an economy.

Managing inflation well is a tough act: if it's too low, the economy doesn't grow as fast, and if it's too high, the economy also slows down, so countries try to keep inflation between 2% and 5% to help their economies grow strong.

This directly explains why the long-term market sentiment trajectory is ultimately dictated by the prevailing inflation control policy.

If you trade stocks, you might not really think about a country's monetary policy. Still, those policies end up shaping the long-term mood of an entire index.

Example of Long Term Sentiment Influenced by Monetary Policy

One example of a market move influenced by a monetary policy is the AUS 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 is a plan to encourage people to spend and also raise inflation to the best levels. When the FED started its Quantitative Easing program, American Stock indices went up because of this feeling in the market, like the Dow Jones index, which went from 10,000 points to 18,000 points.

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 upwards trend. The upward trend soon resumed after the current monetary sentiment resumed back after the speculation for interest rate hike was postponed for a while. All these market moves & heads being influenced by market sentiment that was being driven and pushed by the USA monetary policy.

The EU's quantitative easing program offers another case of policy shifting index markets. It started in January 2015, after cuts to Eurozone interest rates. This boosted long-term views for EU indexes to positive. From January to March, all major European indexes rose a lot. They kept climbing even as the program began 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 Indexes - Such as EURO STOXX, Germany DAX30, France CAC40, Italy FTSE MIB 40, Netherlands AEX 25 & Spain IBEX 25 Index.

For Example, Germany DAX30 went upward 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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