Investor's Corner: Sentiment Indicators Can Help Spot Turns

In other words, don't rely on sentiment gauges alone to decide when to buy or sell stocks.

They can be used as additional data to help you make decisions -- but should not replace careful tracking of the major market indexes and leading stocks.

"Relying on these primary indices is a much more practical and effective method for analyzing the market's behavior and determining its direction," IBD founder and Chairman William O'Neil wrote in "How To Make Money In Stocks."

But sentiment indicators certainly have their uses. These gauges often are referred to as contrarian indicators. When a contrarian indicator goes too far one way, the market often turns to the other direction.

You can find the secondary indicators each day on the General Market & Sectors page (today on Page B2). Most are under Psychological Market Indicators on the right side of the page.

The put-call volume ratio, though, is in the lower half of the S&P 500 chart. This ratio measures put options' volume vs. call options' volume. It goes above 1.0 when options players buy more puts than calls, signaling extreme nervousness.

In the March 15 issue, the ratio soared to 1.47, showing a mad rush to buy puts.

The same day, the Investors Intelligence weekly survey of newsletter writers (Bulls vs. Bears) showed the percentage of bullish newsletters had sunk to 45.5%, its lowest reading since Sept. 1.

So these two indicators pointed to increasing pessimism about the market. As it turned out, the crowd was getting down as the market was gearing up for a new rally.

March 14 was the first day of an attempted rally by the major market indexes. The Nasdaq rose 0.9% (point 1) and the S&P 500 added 0.7%. A week later, on March 21, the market indexes followed through as the Nasdaq rallied 2% (point 2) and the S&P 500 1.7%, on heavier volume.

The bulls vs. bears' contrarian signal also worked in June 2006. Bulls and bears were evenly matched a few weeks before the Nasdaq began to emerge from its correction.

While sentiment indicators don't always predict market turns, they tend to be better at signaling bottoms than tops. Still, action from the market indexes and leading stocks are your primary sources.