Price charts and financial ratios tell you what a company is worth. Sentiment indicators tell you what investors feel about it — and feelings drive prices in the short to medium term just as much as fundamentals do. The core insight of sentiment analysis: extreme readings in either direction tend to precede reversals. When everyone is maximally bullish, there's no one left to buy. When everyone is maximally bearish, there's no one left to sell.
Options traders buy calls when they expect a stock to rise and puts when they expect it to fall. The put/call ratio divides total put volume by total call volume. A ratio above 1 means more puts than calls — bearish sentiment. A ratio below 0.7 means heavy call buying — bullish sentiment. Extreme readings are contrarian signals: when the ratio spikes above 1.2 (extreme fear), markets often rally. When it drops below 0.6 (extreme complacency), a pullback often follows.
The American Association of Individual Investors surveys members weekly: are you bullish, neutral, or bearish over the next six months? Historically, when bearish sentiment exceeds 50% — a rare extreme — markets have tended to rally in the following 6–12 months. When bullish sentiment exceeds 60%, subsequent returns tend to be below average. Individual investors tend to be most bullish near tops and most bearish near bottoms.
CNN's composite indicator combines seven signals: stock price momentum vs 125-day MA, stock strength (52-week highs vs lows), breadth (volume in rising stocks vs falling), put/call ratio, junk bond demand, market volatility (VIX), and safe haven demand (stock vs bond returns). Scores from 0 (extreme fear) to 100 (extreme greed). Extreme readings in either direction are actionable contrarian data points.
The professional use of sentiment: sentiment is a secondary signal, not a primary one. You don't buy purely because sentiment is extremely bearish — a genuinely deteriorating company can get more bearish still. But when fundamentals or technicals are giving a buy signal, extreme bearish sentiment adds conviction: not only are conditions improving, but positioning is deeply pessimistic, meaning the reversal can be powerful as short sellers cover and sidelined buyers step in.
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