Black Swan Insights

Yesterday I noted that the AAII sentiment survey was flashing a warning sign because of the extreme level of bullishness and lack of bears. Currently, the AAII sentiment suvey stands at Bullish 51.2%, Neutral 27.2%, and Bearish 21.6%. Most people who follow this indicator would say this means a sell-off is near. Instead of simply following the consensus, I took a look at the raw data from the AAII survey all the way back to 1-01-04 to see what actually happens when we have similar conditions. The conditions I used were a bullish reading above 51% and bearish number of below 22.0%. I decided to use a 3 week date to see if the indicator was reliable. Here are the results:

Since the beginning of 2004 there have been 24 occurrences (6.7% of the time) that met the criteria stated above
In 15/24 occurences the market declined 3 weeks later, which gives the indicator a 62.5% success rate
It should be noted that during the 1990-2000 time frame this indicator was almost useless with the market continuing to advance despite overly-bullish AAII sentiment

So what can we conclude about the AAII sentiment survey as a trading indicator? Well, we can say that the odds favor a decline in the stock market when bullish sentiment is above 51% and bearish sentiment is below 22%. But the indicator is far from perfect and has a 37.5% failure rate. Another imporant conclusion is that this indicator does not work well in secular bull markets as we saw in the 1990s. Before I wrap up this article, I will leave you with some nuggets from the AAII survey:

The all time record high for bullish sentiment was 75% back on 1-6-00
The market peaked a litte more than 2 and a half months later
The lowest ever reading for bullishness was 12% back on 11-16-90
The market rallied over 13% during the next 3 months
The all-time high for bearish sentiment was 70; 27% reached on 3-05-09 (SP at 713)
3 months later the S&P 500 traded at 932, up over 30%

Overall, you want to trade on the extremes, meaning buy when AAII sentiment is low and sell when it is high. Although no indicator is perfect, AAII is a good one to follow.

Have a good weekend!

Black Swan Insights

Related Articles:
AAII Sentiment At Extreme Level--Sell-Off May Be Imminent

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Is The AAII Sentiment Survey A Reliable Indicator?