THE HAnDbook of TEcHnIcAl AnAlysIsgauging Market tops and bottoms
In order to effectively gauge market tops and bottoms and to subsequently profit
from them, the well-informed should use a combination of sentiment indicators and
classical technical analysis. The gauging of market tops and bottoms tends to be
more effective if the sentiment data from both the flow of funds and opinion polls in-
dicate a level of extreme bullishness or bearishness, occurring at historically or stati-
cally significant levels. The trader or analysts may then employ a range of time- and
price‐projection techniques to seek further evidence for a potential market reversal.
Most important, once a potential top or bottom is forecast, the trader should
always seek price confirmation of the reversal before contemplating risking any
capital in the markets. See Figure 23.2.
reliability of Sentiment readings
The majority of sentiment indicators are contrary indicators, especially if they
track the trading activity or opinions of the under-informed. This is because when
they are most bullish it usually signifies that everyone who wanted to buy into the
market has already done so, drastically diminishing demand. Similarly, when they
are most bearish, most selling would have already taken place, frequently in the
form of a selling climax, and in the process drastically reducing supply. Unfortu-
nately, the opinions polled from the supposedly well-informed have on numerous
occasions proven to be more reliable as contrary indicators.
It should be noted that sentiment indicators work best at market extremes.
Sentiment indicators do not give conclusive indications if the participants are not
experiencing extreme levels of fear or exuberance and acting on those emotions.
Furthermore, the most effective way to gauge if the sentiment of the under‐informed
fIgure 23.2 Market Sentiment.