As an indicator, investor sentiment polls are pretty straightforward -- they offer a comparison of the percentage of respondents who are bullish versus those who are bearish. Peaks in bullish sentiment often precede drops in the market, while peaks in bearish sentiment can often precede a market rally.
Two of the most popular surveys we track are those compiled by Investors Intelligence (II), which conducts a weekly poll of financial advisors, and the American Association of Individual Investors (AAII), which asks its membership each week whether they're feeling bullish, bearish, or neutral toward stocks.
Surveys of the bullishness or bearishness of investors and advisors make for excellent contrarian readings at extremes. On one hand, excessive bullishness can indicate that buying pressure has peaked and that the risk of a negative surprise is heightened. On the other hand, if pervasive bearishness among investors exists, even bad news won't necessarily cause the market to go down any further since the selling has already occurred in advance of this news.
As contrarians, we like to look for situations where these surveys show a high percentage of pessimism while stocks are moving higher. This indicates to us that not everyone has bought into the rally, and there are still plenty of sideline buyers who could contribute to additional upside. Alternately, if everyone is optimistic in the midst of a bear market, that's a troubling sign that the downtrend may continue until these remaining bulls have capitulated.