Investor sentiment is one of the pillars of behavioral finance and defines the general attitude towards future market prices. Investors form their opinion based on facts and their gut feeling. Fundamental and technical factors are examples of facts, whereas stories and opinions of other investors are examples of narratives, which contribute to attitudes.
Investor sentiment is important because it affects the fundamental principles of asset pricing. There has been plentiful of evidence-based research published on the topic of investor sentiment. The consensus among researchers is that extreme readings of investor sentiment tend to be a contrarian indicator. Excessive levels are associated with subsequently surprising asset returns to the opposite direction of expectations. Hence, strongly bearish expectations were followed by positive returns, whereas negative returns followed strongly bullish expectations.
The ESI Retail Sentiment Index is a gauge for retail investors’ risk inclination. It is an algorithmic data mining indicator that extracts information from public sources on the internet. The indicator aggregates risk-relevant terms and constructs a time series from that. An overlay to the S&P 500 index shows the behavior of the sentiment gauge during the past years. The index is published every Thursday before the New York Stock Exchanges opens.