Individual Investors Turn Bullish: A Bet on the Wrong Side

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Last week’s news that a COVID-19 vaccine could be available before the end of the year sent major stock market averages higher. But investor sentiment tells us that those gains may reverse over the next few weeks.

The actions of individual investors seem to have driven last week’s gains. These are the least sophisticated investors. They also have the least amount of money to put work in the stock market.

Because of this, individuals don’t generally drive sustainable price trends.

The chart below includes some of the data showing that individuals shifted from bearish to bullish in large numbers last week:

“Are You Bullish, Bearish or Neutral About the Next 6 Months?”

sentiment turns bullish

Source: AAII.

Why This Extreme Shift in Investor Sentiment Matters

This chart shows the results of a weekly survey conducted by the American Association of Individual Investors, or AAII. Data extends back to 1987, and the survey has been the same for more than 33 years.

There’s just one question: Are you bullish, bearish or neutral about the next six months?

The survey’s long history allows us to test the usefulness of the data.

Extreme shifts in investor sentiment, like the one we saw last week, are important.

In the past, shifts like this came right before major market reversals.

This is because when most individual investors are bullish, they have already put cash to work in the market. Without a reserve of cash on the sidelines, there isn’t a catalyst for additional gains.

History confirms this logic. The last time the bullish percentage topped 55% was January 2018. The S&P 500 dropped more than 12% over the next two weeks.

A similar reading in December 2014 preceded a two-week decline of more than 5%.

In other words, the bull market ends when we run out of buyers.

And with so many investors turning bullish last week, we might be running out of buyers.

Michael Carr is a Chartered Market Technician for Banyan Hill Publishing and the Editor of One TradePeak Velocity Trader and Precision Profits. He teaches technical analysis and quantitative technical analysis at the New York Institute of Finance. Mr. Carr is also the former editor of the CMT Association newsletter, Technically Speaking.

Follow him on Twitter @MichaelCarrGuru.

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