Should The Stock Market Be Used To Gauge Risk Sentiment?

Equities are generally considered a higher risk investment asset. Price movements are a clear indication of fear or greed in the market. Equity prices in isolation do not give a fully accurate picture of risk tone and should be used with other assets.
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The Stock Market And Risk Sentiment Explained

A quick question from Drackson asking us what is the pros and the cons of using the stock market to gauge the overall risk on and risk off sentiment.

Now, the reason why equities or let’s call it the stock market is such a good gauge of overall risk sentiment is due to a couple of factors.

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Firstly, equities are considered a high risk asset, especially when it’s compared to something like a US government bond. Thus, they are very good, let’s call it gauges of the overall mood of investors and whether there is appetite for risk in the market or not.

Secondly, as short term stock markets are very sensitive and basically driven by emotions particularly greed and fear, risk on and risk off. It is one of the first places where a sudden change or a quick change in the sentiment can be observed as traders try and scramble to make sure that they are on the right side of their changing mood you know, from second to second.

Thirdly, even though the underlying equities only trade or move during the exchange traded hours. We do have equity futures like this example on investing.com. Where we have basically the Asian session, European session and New York session equity futures. And that can give us a very quick snapshot of whether the global market sentiment is down or up at a very quick glance which is useful info for us to have. Whatever they are obviously a couple of cons like you said, that we need to keep in mind.

Firstly, the market let’s call it the the bigger market is never moved just based on one thing, it’s never just moved by equities. There are always multiple factors that can influence price moves across asset losses, which means equities might not always give us the right type of signal.

For example, let’s say the stock market has fallen over 10% yesterday due to a very strong risk of tone in global markets. At some stage, it wouldn’t be unreasonable to expect a pullback of that move to happen whether that is the next session or the next day.

Now, that pullback might not be due to a positive change in the list or it might just be because of profit taking from that big move down. But at face value, if you look at your equity screen, you might be seeing equities as being all green across the board. And that can be sometimes be a little bit confusing.

But then also, we need to look at to make sure that we’re looking at other asset losses as well, like currencies like commodities, like the bond markets, and basically understanding the reason for why are we seeing green across the board and equities, but not maybe the same effect in other markets as well.

Another good example would be if equities, let’s say are all right across the board, but we don’t see the same reaction in other asset losses or equities or rate but we see commodities are trading up high beta currencies are trading up safe haven currencies are trading down gold is trading down just as an example.

Now, that might be due to other individual factors that might be pushing equities lower, such as earnings, disappointments, and that in itself can obviously change the overall market sentiment but it might not necessarily always have an impact on rest of the market you know transmission effects into currencies and commodities et cetera.

So, in that sense, equity markets are very, very useful it is something that we use on a daily basis that we need to gauge on a daily basis. But they are just one cog which forms part of a much bigger market machine. And as fundamental traders we need to use each asset loss whether that is equities, commodities, currencies, etc, in its appropriate setting and gauge the overall or the macro view to make a calculated decision based on the info that we have in front of us within the markets trading risk of whether the market is trading risk on.

So I hope that helps you out the tracks and if there’s any other questions, please let us know.

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Kerry Fletcher

Would you say that looking at the stock market though is generally a ‘lagging’ indicator then? Or is it a leading indictor? Thank you for your great videos. It’s really helping to ‘get’ this fundamental trading. I’m really getting into the ‘news based’ trading. I love it now. What a feeling when your open position goes straight into profit. This NEVER used to happen to me before. You’ve definitely got my attention! So thanks!

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