We’ve often stated that the best use of our Twitter sentiment indicator is to confirm the trend and warn of a pause (or consolidation) in the trend. It is not like other sentiment indicators who’s major use is to act as a contrary indicator. However, we’re starting to see a pattern in the sentiment of some of the most loved stocks that is somewhat contrary in nature.
The pattern occurs in stocks that have too much love. These are stocks that every trader, investor, and fund has to own. These stocks have so much love and such a cult following that positive emotions rule the sentiment. We’ll start with a chart of Baidu (BIDU). Take a look at smoothed sentiment from early June 2012 until early November. Notice how it had a hard time of ever getting below zero even though the stock was clearly in a down trend and had been for over a year. Traders loved this stock. They saw every dip as a buying opportunity. Even the serious break down in price in early November did very little damage to sentiment.
It wasn’t until the gap down in price at the first of February this year that trader’s sentiment started to capitulate. The evidence of capitulation occurred when smoothed sentiment fell sharply with price and daily sentiment stayed below zero for several days. During this time period the volume and intensity of tweets diminished substantially. Each dip in price didn’t generate as much angst (higher intensity). The rallies in price showed a lack of enthusiasm with tweet intensity dropping. So smoothed sentiment showed capitulation in trader’s opinions, while intensity slowed on rallies. This is the condition we want to point out as a contrary indicator…kinda.
To be specific, what we believe is that a go go stock in a down trend needs to lose support from its most ardent supporters before it can make a durable low. The vast majority of traders who love the stock must be burned enough by failing rallies that they step aside. This allows the stock itself to make a low supported by longer term investors and/or value players. The pattern in sentiment that we mentioned above provides the clue that traders are finally all out of love for the stock.
The chart of Apple (AAPL) gives us another example. During a 40% draw down in price, smoothed sentiment for AAPL didn’t ever get deep into negative territory. When it did dip below zero it was always for just a few days. Traders loved this stock even though it continued to burn them. During this time period you could see more people leaving the AAPL party by observing the volume and intensity of tweets diminish. Intensity also painted a pattern of rising when the stock fell and falling when the stock rose. This told us that fewer people were supporting each rally and more people were interested in the stock falling. As we mentioned last week we think we’re starting to see the beginnings of a bottoming process for AAPL. We don’t think the stock is there yet, but it is much closer. For now, sentiment is confirming the down trend so the most likely path is down. Our first sign that the stock may be putting in a low will be smoothed sentiment painting a positive divergence with price.
Gold (GLD) has painted a similar pattern, but without the large differences in intensity. Unfortunately, this might mean GLD has a lot more work to do before finding a low. We’ll be watching this ETF closely for any signs of a bottom…or of course confirmation of lower lows.