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An Overview of Expectational Analysis
An edge. That's what every trader looks for. But there's no Holy Grail intrading and investing, at least not yet. So for now, we'll just have to settle for that unique edge that gives us a leg up on the competition.
Investor Sentiment: The collective feelings, moods, beliefs, and in some cases actions of investors.
Schaeffer's Expectational Analysis Model
As previously mentioned, our edge (and hopefully yours after you complete this program) is in the area of sentiment. When combined with fundamental and technical factors (a methodology we call Expectational Analysis), sentiment can be a powerful tool for analyzing stocks, sectors, or the overall market.
We also stated that do-it-yourself investors usually focus on one or two traditional approaches to stock selection: fundamental analysis, which uses such factors as earnings, dividends, price-to-earnings (P/E) ratios, and economic projections to forecast stock prices; and technical analysis, which focuses on historical price patterns, charts, and volume characteristics to gauge future performance. At Schaeffer's, we combine these important methods with the all-important third ring - sentiment, which evaluates the opinions and feelings of the investing community.
The sentiment indicators that you learned about in the previous chapter are then overlaid with fundamentals and technicals to help project stock price movement. The synergy of these three methods is the basis for Expectational Analysis, which is vital to our stock and options trading success. This program attempts to heighten your awareness of the importance of this expectational element in forecasting future stock prices. Such awareness is rare among options traders and thus should always provide you with an important trading edge.
So what is sentiment and why do we consider it so important? Investor sentiment is simply the collective feelings, moods, beliefs, and in some cases actions of investors. The most accurate sentiment indicators generally reflect what a group of investors is actually doing as opposed to what they're feeling and saying, although the latter has a degree of validity.
In The Art of Contrary Thinking, Humphrey Neill emphasized the importance of measuring the sentiment of the "investing crowd", believing that their actions parallel the behavior for any crowd. It is important to think critically and thoroughly in developing one's investment decisions. This gives you an immediate advantage over the average investor, who would rather run with the crowd and lose conventionally than win unconventionally by going against the grain.
There is this perverse logic, especially among money managers, that if everyone is down 20 percent and the manager is down only18 percent, he has done a superior job. This type of thinking leads to mediocre performance, as the manager attempts to beat only the average manager's return rather than the market itself. In reality, the investor should seek to produce absolute gains instead of worrying about a benchmark. You want to make sure you avoid the rationalizations of the crowd, as you should care about maximizing your reward while minimizing your risk. Your account doesn't give you bonus points for losing less than the benchmark; it only responds to actual dollars gained or lost.
Obvious Think
When average investors feel compelled to think, they tend to involve themselves in "obvious thinking," or thinking in the same way as everyone else. This thought pattern commonly leads to wrong judgments and wrong conclusions, particularly in the stock market where it does not pay to invest in the same direction as the rest of the crowd once the optimistic extreme is clearly in view.
The proper application of our Expectational Analysis approach helps you avoid thinking like the crowd, because you tend to think critically and independently and are not seduced by the obvious. It also leads you to measure the sentiment of the masses so that you can adopt an opposing viewpoint against the crowd, but only when appropriate at important extremes in crowd behavior. You must remember that the crowd is not always wrong. It tends to be right during the heart of a market trend, but decidedly wrong at the major tops and bottoms. As Humphrey Neill said, "the public is right during the trend but wrong at both ends."
The fact that the public is not always wrong is one of several major misconceptions about contrarian theory, and is one of the major factors that tripped up so many analysts concerning the bull market of the 1990s. Time and again, the public's infatuation with the stock market - as manifested by the huge dollar inflows into equity mutual funds - has been trotted out by the bears as an argument that the end of the bull move is at hand. And those who have ignored the idea that the public is right most of the time have paid a severe price. The public will be overly enthusiastic and overly invested at the ultimate top. Such enthusiasm is a necessary, but not a sufficient condition for a top to be in place.
Remember that the only condition that can push a stock higher is when buyers out number sellers.
Think Like a Sentimentician
Expectational Analysis is not about bottom fishing or buying low-priced or cheap stocks. "Cheap" can always become "cheaper." And it's just as dangerous to mindlessly try to catch a "falling knife" in a stock that is in a free-fall as it is to buy a stock just because it is achieving new highs. As a "sentimentician," you should tend to be attracted to stocks on which expectations are low, generally avoiding the crowd. On the other hand, if the crowd overly loves a stock or a sector, you should tend to steer clear of it.
In other words, success in investing is about buying low expectations, not about buying low prices. In fact, it is often best in the Expectational Analysis methodology to have a philosophy of "buying high and selling higher." With strong technicals and positive fundamentals and adding investor sentiment analysis to identify low or moderate expectations, you are now using the expectational approach to identify stocks to consider for your portfolio. Expectational Analysis can successfully help you select the best investments that the rest of the crowd scorns. In addition, you can avoid overly popular stocks that possess limited upside potential. During bear markets, this strategy can help you profit by buying put options on down trending stocks that the public has not yet given up on but is likely to soon dump, while avoiding calls on the dogs that won't hunt.
Success in investing is about buying low expectations, not low prices.
As expectational investors, we infer that by the time we see that virtually everyone is bullish, we can bet that buying strength is likely depleted and any declines are apt to be significant. Conversely, by the time we see that virtually everyone is bearish, we infer that selling strength has likely been depleted and a major move upward is probable in the very near future. Remember that the only condition that can push a stock higher is when buyers outnumber sellers. Thus, the stock of an over loved company is not likely to rally regardless of the strength of the company. An Expectational Analysis approach is simple, but it can be lonely. After the1987 crash when bearish sentiment was at a peak, you would have been quite alone if you were bullish. But you would have been right.
Such was the case with Bernie Schaeffer, who used sentiment analysis to call the market top in August 1987 and then turned bullish at the exact market bottom after the crash. The contrarian nature often separates those using sentiment from those relying on only fundamental and/or technical analysis. Of course, this is what frequently positions expectational analysts to catch key turning points ahead of the crowd; yielding profits from what others would have termed "surprises."
Though the 1987 crash is the most famous example, Bernie Schaeffer has used sentiment reads and Expectational Analysis to catch many market turns and pivotal moments. Because Schaeffer's research has applied sentiment analysis to the individual stock level, we use sentiment every day to uncover the strongest opportunities ahead of the crowd.
How Expectational Analysis Applies To the Stock Market
Using sentiment provides a framework to help describe the various stages of a bull-market rally or a bear-market decline. As market participants (largely represented by the nation's press and individual investors) progress through these four stages, the chances for a reversal in the trend increases. Below are the four stages of sentiment underlying the transition from a bear to bull market:
- "Despair"
At a market bottom, there is an overwhelming sense of despair among market participants. Investors are hopeless, and magazine covers are proclaiming the worst. An old idiom says the night is darkest before the dawn. This theory is true with the stock market, as a firm bottom based on desperation and hopelessness must be in place before a true recovery can begin.
- "Disbelief"
During the initial advance from a major market bottom, there is a sense of disbelief until the rally proves itself. For example, disbelief was the overwhelming emotion in 2003 when technology stocks began to rally from the depths. This disbelief, or wariness, is often manifested by a continued preponderance of short selling or an absence of call buying, even though the market has shown considerable strength.
- "Acceptance"
The middle stages of the rally spur a sense of acceptance among market participants, as investors begin to believe that a bull market is possible. The Art of Contrary Thinking states, "the public is right during the trend, but wrong at both ends." The middle stage of a market rally constitutes a trend and the public is right in accepting it.
- "Euphoria"
Euphoria is the final stage and is generally cause for concern, as too much optimistic sentiment tends to precede the end of a market rally. If everyone is euphoric and putting as much capital as possible into the market, there isn't much left on the sidelines to continue propelling the market higher. It is at this point when the bull market will do an about face and begin to retreat. In other words, by the time the weaker hands are invested, the market becomes most vulnerable.
Remember that the same stages hold true when a bull market morphs into a bear market. Euphoria (seen at the top) evolves into disbelief, as investors cling to the shadow of a bull market even if the technical picture shows otherwise. Before a bottom is reached, marked by despair among investors, there will be a general feeling of acceptance, as market participants scurry to protect their portfolios from the inevitability of bear-market drawdowns.
The "price" of a stock reflects the current sum total of investor expectations.
How Expectational Analysis Applies To Stocks
It is vitally important to remember that the "price" of a stock reflects the current sum total of investor expectations. If these expectations are too low, a stock will have a tendency to rally and trade higher. Only over time after investors have bought into the stock's story will this gap narrow and the stock price move to a more appropriate level (reflecting reality). Similarly, if expectations are too high, there is a tendency for a stock to decline in price as these high expectations are eventually adjusted downward to better reflect the real world.
There's no such thing as an infallible indicator, and sentiment is no exception. But without a feel for the expectational environment surrounding a stock, your analysis is not firing on all cylinders. You may very well have a handle on the fundamentals and technicals, but very often it's the expectational - or sentiment - backdrop that makes the difference. For example, have you ever been at a loss to explain why a stock goes down despite an earnings report that met or even beat expectations? This is especially frustrating when you see another stock that met expectations rally furiously. What's going on?
The answer is often contained in the differing expectations surrounding the two stocks prior to the event. In one case, the sentiment may have been excessively bullish heading into the report. There could have been a build-up of call options and thus a lot of anticipatory buying of the stock, which then becomes exhausted by the time earnings are reported. Such a high-expectation environment creates a heavy burden on the stock to issue a blowout earnings report.
On the other hand, there could have been a general concern about a company's fiscal health and some expectations that earnings might be missed. The result? Increased put buying and shorting activity, which is eventually unwound as the company exceeds lowered expectations.
Why are expectations so important? Because the price of a stock represents investors' perceptions of reality and often these perceptions are excellent contrary indicators. A stock with relatively low expectations stands a good chance of rallying, as the price will rise from this artificially low level to one that reflects the "real world." Conversely, high expectations can put downward pressure on a stock, as the price adjusts itself lower from its unrealistic heights to better match reality.
Put another way, low expectations translate into potential buying power, as skeptical investors (and their money) wait on the sidelines, ready to bolster a stock's appreciation by buying up the supply from profit-takers. When news occurs on a company or a sector that is either favorable (or not as unfavorable as expected), the sidelined money begins to flow back into the stock - sometimes slowly, sometimes quickly - depending upon the degree of skepticism prevailing in the stock or sector. As further bullish and up beat stories are reported, there is more acceptance of the bullish argument. This excess demand drives the price even higher. On the other hand, high expectations usually mean that most of the sideline money has already been committed to a stock. Buyers are now scarce and selling will predominate on any perceived negative news, leaving the stock more vulnerable to a significant decline.
Essentially, expectations become so high again that the buying power is exhausted, setting up for a downside reversal to take place as the sellers take over.
Low expectations translate into potential buying power.
High expectations often leave a stock vulnerable to decline.
One of the most important tenets of our Expectational Analysis approach is that the power of a contrarian indicator is much greater when the underlying sentiment runs counter to the direction of the stock. For example, pessimism would be an expected reaction to a down trending market and thus would not be a valuable contrary indicator. On the other hand, skepticism in a rising market is a powerfully bullish combination, as market tops are not seen until optimism reaches extreme levels.
Investors are normally quite optimistic during bull markets and quite complacent and relatively lacking in fear on pullbacks in bull markets. It then becomes an art for the sentiment analyst to determine when this bullish sentiment has reached an extreme, at which point buying power will have become dissipated to such an extent that the market will top out. But when negative sentiment accompanies a bull market, the task of the "sentimentician" becomes much easier, as it is thus clear that buying power has not yet been dissipated and that the bull market has further to run before a top.
Using Expectations for Options Trading
You can rate individual stocks as either "high expectation" or "low expectation," relative to their underlying technical trend and fundamental outlook. "High expectation" stocks, by definition, are stocks to avoid or to consider selling short. Better yet, buy puts on these stocks to benefit from the leverage and limited risk of options. Remember that selling short involves selling a borrowed stock. If the stock goes up you are at risk. Meanwhile, a put purchase gives you the right to sell the stock at the strike price, so if you expect a stock to drop significantly, you would buy a put on that stock. But if the stock moves against you and goes up, all you can lose is the premium paid. You are not exposed to any further upside risk.
"Low expectation" stocks, on the other hand, are ripe for big gains on any positive development, as there are very few buyers who have committed to support the shares. These equities should form the core of your "buy list" for call trades. Remember that call options offer the right to buy a stock at a certain fixed price no matter how high the stock price. So buy calls if you expect major gains in a stock.
Use sentiment to add significant value to traditional technical analysis.
If you want to know what stocks are truly "high expectation" or "low expectation" situations, you need to first have an objective way of measuring the sentiment (or consensus opinion) on those stocks. Then you need to compare these expectations against the prevailing technical and fundamental trends to determine whether these expectations are in line with reality or not. For example, if the technical and fundamental trends are positive and the sentiment is skeptical, this "low-expectations amid strong technicals and fundamentals" scenario tends to be very bullish.
Objectively gauging sentiment can add substantial value to traditional technical analysis, because sentiment extremes are not visible on the charts and can only be viewed and measured by a separate class of sentiment indicators (as discussed in the previous chapter). A trend that is about to end cannot be distinguished on a chart from a trend that has a long way to go in price and time. In fact, there is an old saying in technical analysis to the effect that "the chart looks prettiest just ahead of a top." But sentiment indicators can help you distinguish the pretty chart that is going to remain pretty from the pretty chart that is about to turn ugly. As you incorporate Expectational Analysis into your trading routine, remember to refer to Chapter 7 as a handy reference for the most useful and meaningful sentiment indicators.
Market-Timing Magic
Sentiment indicators measure the emotions and expectations of investors in the market. Like most emotions, sentiment can change and it's not unusual for it to swing from bearish to bullish (or vice-versa) in a short amount of time. In order to be effective, sentiment analysts need to rely on more than just "gut feelings" to determine what will happen in the market. A true sentimentician will be in tune with the market, aware of what the stock's past trends have been, and be willing to make a call as to whether public sentiment is about to peak or reverse. You read earlier about Bernie's exceptional calls surrounding the 1987 crash. Using sentiment to perform market-timing "magic" has kept Bernie's average rankings in the top five over the past five years among a group of approximately 100 of the nation's top market timers as measured by Timer Digest.
Bernie is also ranked as the #1 Gold Timer by Timer Digest since 1995, and has taken top honors on three occasions in the Wall Street Journal's stock-picking contest.
The following charts and quotes demonstrate examples of the power of sentiment through Bernie's recent market calls. As you read, consider:
- what was going on in the market at the time
- what was being predicted by mainstream fundamental and technical gurus
- what the press was projecting
Time and again, it was the sentiment element of our Expectational Analysis approach that made the difference. (Most of the calls listed below appeared in Schaeffer's flagship publication, Bernie Schaeffer's Option Advisor, and other special alerts sent to subscribers of our various services. For information on these services, go to SchaeffersResearch.com.)
Bernie Schaeffer: Market-Timing Accuracy
- October 27, 1994 (Figure 8.1)
"You are looking at an unusually attractive and potentially historic buying opportunity right here. Equity and mutual-fund players should buy stocks and equity funds with both hands in preparation for a major rally."
- February 23, 1995
"The surprising low level of investor expectations gives me a very strong 'blastoff' message."
- September 21, 1995
"Are we at or near a market top now? Not on your life!"
- November 20, 1995
"That places the Dow at about 5,500 by April1996, a projection that sits well with me." Note: The Dow first crossed above 5,500 in February 1996!
- November 25, 1996
"We look for a resumption of the market's uptrend and view the current pullback as an opportunity to accumulate stocks."
- February 27, 1997
"I strongly believe that this bull will survive Greenspan's temporary obsession with 'high' stock prices."
- May 13, 1997
"The average six-month gain (following a specific put/call ratio reading) was approximately 19 percent, so based upon this data and reflecting the 8-1/2-percent gain that has already occurred, the market would be approximately 10% higher by the end of October. This would place the Dow at about 8,000." Note: The Dow crossed above the 8,000 threshold in mid-July 1997!
- July 28, 1997
"The bottom line is that this bull market is more vulnerable to a short-term correction than it normally would be due to some of the recent speculative excesses, but such a correction is by no means assured, and if it occurs, it is very likely to be of the 10-percent variety such as those that occurred in July 1996 and in April1997. And, as I stated last week, we have not seen the ultimate top for this bull market."
- December 31, 1997
"With renewed money flows into equity mutual funds and a continuing positive interest-rate backdrop, we look for the market to climb to the 9,000 mark by the end of March." Note: On April 2, 1998, the Dow did indeed hit 9,000!
- March 29, 1999
"I stand by my forecast that the Dow will reach 11,500 in 1999. All of the bullish factors that I set forth in my 1999market forecast remain in place." Note: On December 31, 1999, the Dow closed at 11,497!
- September 9, 1999
"Perhaps the most important benefit to the Y2Kcrisis is the fear that it has created throughout the world's financial markets. Y2K has turned out to be a rather substantial and persistent ingredient in the 'wall of worry' that has sustained this long-running bull market of late. As long as these fears persist, there will be sufficient sideline cash available to pour into stocks once fears subside."
- October 21, 1999 (Figure 8.2)
"So fear is clearly in the air; yet so far, this pullback in the major averages has held at key support levels …High levels of fear on bull market pullbacks to support are harbingers of further gains, so hang on for what might be a rough, but ultimately rewarding, ride." Note: In addition to the Nasdaq Composite's subsequent surge, the SPX bottomed that week at 1,233.70 before embarking on a huge rally that saw the index gain 26 percent over the next five months.
- December 16, 1999
"I expect the Nasdaq Composite to soar about the 5,000 mark [in 2000]." Note: The COMP moved above 5,000 in March 2000.
- April 28, 2000
"Is there potentially some more downside from here? Yes."
- October 9, 2000
"My biggest concern right now is that the market-bottoming scenario has become too pat, and the fear levels are not where they need to be to justify a bottom right here and right now."
- December 1, 2000
"I'm now switching my long-term posture from 'bullish' to 'neutral…' On Thursday, November 30, the SPX experienced its first monthly close below its 20-unit monthly moving average since 1994." Note: The SPX did not move back above this long-term trendline until July 2003.
- February 27, 2001
"I'm now turning 'bearish…' the behavior in the S&P 500 Index in the coming months is likely to differ from its behavior over the long bull market … [There is also] potential for a close this month for the first time in over a decade below [the SPX's]40-month moving average." Note: The SPX did not close back above this trendline until December 2003.
- April 26, 2001
"…we still contend that the bear market is not dead."
- June 21, 2001
"But I feel the odds strongly favor a broad washout before this bear market is over, if only because the lack of a broad market breakdown beyond tech is the single strongest factor supporting the continued high hopes for a rapid stock market comeback."
- October 25, 2001
"So there is upside from here, but I'm playing this rally with one eye focused on the exit door. First and foremost, while we've recovered to pre-attack levels in the market, this in no way negates the fact that we're in a bear market, and the technical position of this bear market is the worst since 1974."
- November 15, 2001
"While our short-term sentiment indicators suggest this advance still has legs, I cannot help but keep Neill's words in the forefront of my mind as I see potential resistance levels… that linger overhead."
- January 24, 2002
"And finally, when will the narrow trading range be penetrated? Soon." Note: The S&P 100 Index (OEX) resolved a three-month trading range to the downside on February 4, 2002.
- March 21, 2002
"But I strongly believe that the time has come to take some serious measures to anticipate a major market decline before 2002 is over …" Note: The SPX tumbled 24 percent by September 2002.
- May 29, 2002
"…we do not foresee a solid end to this bear market until a solid level of fear is prevalent in the marketplace."
- July 25, 2002
"Bottom? Probably not."
- October 22, 2002 (Figure 8.3)
"So what's next? Perhaps more upside."
- November 14, 2002
"Traders should look at tech names for potential short-term gains."
- February 27, 2003
"…technology in general and small- and mid-cap technology in particular [are] worthy of some dabbling this year by long-term investors."
- May 22, 2003 (Figure 8.4)
"Invest 5-15 percent in gold stocks. Gold is a hedge against the entire spectrum of economic nightmares…"
- August 21, 2003
"The bears are going to continue to pay the price over the short to intermediate term."
- August 21, 2003 (Figure 8.4)
"I recommend that you keep some serious exposure to gold stocks."
- November 20, 2003
"So am I prepared to declare a market top right here and now? Not quite. While I do believe this market is running out of firepower, it is not yet running on fumes."
- January 22, 2004
"The bottom line is that it appears that the market will not get the big lift from earnings that many had expected."
- June 24, 2004 "Is the risk of a major market decline much higher than usual because of the potentially deadly combination of investor complacency and a huge laundry list of economic and geopolitical risks that are not priced into the market? Yes."
- July 13, 2004
"I envision a possible scenario in which tech stages an earnings-induced rally over the next couple of weeks that will flush out any residual short-term bearish sentiment."
- July 19, 2004 (Figure 8.4)
"…a three-year rally in gold, even one that has taken the metal 70 percent higher, hardly makes a dent in terms of relative strength when compared to stocks. So I see a rally that is far from being ready to cash in its chips."
- October 25, 2004
"So while I continue to harp on the dangers lurking in this market, urging a healthy allocation to the safety of cash, save some room for gold. It might just be the brightest part of your portfolio."
Expectational Analysis - Hypothetical Examples
Using what you've learned in the past three chapters, let's try a few hypothetical examples to reinforce what defines a bullish or bearish Expectational scenario.
Example One:
- Stock XYZ has been trending lower for six months.
- XYZ has been underperforming the broader market over the past year.
- The stock's Schaeffer's put/call open interest ratio (SOIR) is in the lowest one-quarter of the past year's worth of readings.
- Analysts have given XYZ 10 "buys," 3 "holds," and 1 "sell" rating.
- Short interest is negligible.
Is this a bullish or a bearish Expectational backdrop?
Example Two:
- Stock ZZZ has been in a strong uptrend and has pulled back to potential intermediate-term support at its 10-week moving average.
- The company has surpassed analysts' earnings estimates for the past five quarters.
- The stock's SOIR has been trending upward and is higher than 85percent of the past year's readings.
- Analysts have given ZZZ 4 "buy," 12 "holds," and 3 "sell" ratings.
- Short interest represents 10 percent of the stock's float and would require more than eight days of trading (at ZZZ's average daily volume)to cover.
- Time Magazine featured a cover story doubting the company's ability to continue growing its sales.
Is this a bullish or a bearish Expectational backdrop?
Example Three:
- Stock ABCD has outperformed the broader market for three years and is up 60 percent over the past 52 weeks.
- The company recently boosted its earnings guidance for the fiscal year.
- Short-interest numbers have been falling, and all of the current shorted ABCD shares could be covered in less than two trading days.
- There are 11 "buy" ratings on ABCD compared to two "holds" and no outright "sells." Call options are the dominant presence in ABCD options trading, and the stock's SOIR is near an annual low.
Is this a bullish or a bearish Expectational backdrop?
The first two examples are fairly straightforward - the first is bearish while the second is bullish. Both display sentiment that runs counter to the prevailing technicals and fundamentals. This tells us that investors and Wall Street have not yet bought into the current trends, which should allow them to continue. These are ideal Expectational Analysis plays, as the misguided sentiment supports the strong or weak technicals and fundamentals. In reality, these scenarios are the exception, not the rule. It's a rare find when all or most indicators line up just so. But finding them defines our edge.
The third example is a bit trickier. Although the stock looks attractive from a technical and fundamental standpoint, there are not enough sentiment factors to provide a winning argument from an Expectational Analysis perspective. In other words, optimism (declining short interest, low SOIR, a high number of "buy" ratings) is to be expected given the strong technicals and earnings news. It's natural to see bullish sentiment on an outperforming stock (or bearish sentiment on an underperforming stock). It's when the sentiment indicators run counter to the technical and fundamental trend of the underlying stock that an ideal Expectational Analysis profile is established.
Schaeffer's Daily Contrarian Our Take on Stocks in the News Today
How Schaeffer's Daily Contrarian Can Boost Your Portfolio
In the spirit of Expectational Analysis, we have a feature on SchaeffersResearch.com that illustrates our contrarian approach quite well. At Schaeffer's, we have a team of analysts who track "anecdotal sentiment" gleaned from the nation's media and pull it all together for our in-house research. One offshoot of this research is found in our daily web-based column, Schaeffer's Daily Contrarian.
This column features daily summaries of current articles and provides a short take on how we view the article in a contrarian light (if applicable).Our goal is to constantly scan various media and news outlets every trading day and present those articles that we feel provide a good contrarian read. We should note that not all articles will lend themselves to a contrarian interpretation.
Schaeffer's Daily Contrarian is not meant as a trade recommendation. These articles and our contrarian interpretation are but a small piece of a much larger analytical puzzle. Gathering anecdotal sentiment from a variety of sources and merging this with hard data is the hallmark of contrarian analysis. Here you get a first-hand account of how to go about this in real time.
It's also important to understand that deriving a contrarian read from an article is by no means a poor reflection on the publication or its writers. A negative article on a high-flying stock may cite accurate facts and be extremely logical. And more importantly, it could ultimately prove to be correct. However, experience has taught us that uptrends do not end until the final capitulation, where it seems that everyone has finally given up their concerns. The market has shown time and again that short-term moves are often driven purely on emotions. By monitoring the comments made by analysts in the media, we can add this to our contrarian arsenal to gauge whether the capitulation stage has finally been reached.
At Schaeffer's, we have the years of experience and the ability to "peruse the piles of news." More importantly, we are willing to share it with you everyday. It's almost like having your own personal team of contrarian analysts gathering and summarizing anecdotal information. We hope Schaeffer's Daily Contrarian becomes a resource you value as much as we do.
Schaeffer's Daily Contrarian Example:
On July 12, 2004, the following Schaeffer's Daily Contrarian featured pessimistic positioning toward Apple Computer within the pages of the July 6 Financial Times (Figure 8.5).
AAPL rocketed 150 percent higher in the six months following this article's publication (Figure 8.6). Strengthening demand for the iPod, the introduction of new products, impressive earnings results, and a continued cloud of skepticism all contributed to the equity's success.
Pulling It All Together
As you have learned, Schaeffer's believes that a methodology rooted in Expectational Analysis is crucial to making good investment decisions. Adding sentiment to your arsenal of analytical tools can greatly enhance your trading performance. With a number of sentiment indicators at our disposal, there are four major principles that you must understand when using the expectational approach:
- First, the strongest contrarian implications by far are when there is bearish sentiment during rallies and bullish sentiment during declines.
- Second, bullish sentiment during rallies and bearish sentiment during declines have the weakest contrarian implications, as they are to be expected.
- Third, if you are going to trade counter-trend based on sentiment that is in line with your trend, you will be most successful during declines when sentiment becomes very bearish and will be least successful during rallies when sentiment becomes very bullish.
- Fourth, the crowd can always turn more bullish or bearish, even when sentiment seems to be at extreme levels.
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