Trading the Bull/Bear Ratio

Adam Hamilton     May 23, 2003     3494 Words


The financial markets in which speculators ply their trade are exceedingly emotional arenas.  Capital is an emotional thing and so many countless hopes and dreams are riding on practically every trade.  Winning on a speculation creates an awesome natural high while losing can lead to a broad array of negative feelings.


When the emotional nature of capital is mixed with us hopelessly emotional humans ultimately making all the trading decisions, the highly volatile end result is markets perpetually buffeted by endless blizzards of emotions relentlessly assaulting from all sides.


One of the great ironies of the marketplace is the striking disconnect between research and actual trading.  Investors and speculators spend countless tens of billions of dollars every year on research designed to view the markets through a cold, objective, and unemotional lens.  Yet, even armed with this expensive and hard-won knowledge, the majority of market participants still trade almost exclusively based on their own dangerous individual emotions!


Truly the ultimate driver of virtually all short-term market movements is emotion, specifically greed and fear!  As speculators we cannot even begin to understand short-term market movements until we wrap our minds around the phenomenal power that the collective emotions of the thundering herd of investors and speculators command.


Indeed, the very study of the art of speculation is often the study of emotions, painstakingly examining both one’s own greed and fear as well as the vast collective greed and fear dwelling within the hearts of other market players.  In order to grow into a successful speculator, one has to somewhat paradoxically learn to mercilessly suppress his or her own market emotions while at the same time becoming hypersensitive to discerning the emotions of others!


The very essence of contrarian speculation involves recognizing when the majority of the thundering herd has grown too greedy or too fearful, and then promptly deploying capital in the opposite position.  The majority of investors and speculators always have and always will act like sheep and merely reflect the emotional state of the flock, becoming far too greedy near the top of a trend and far too fearful near the bottom. 


Contrarian speculators can exploit this popular emotional overload to execute superior trades near major turning points.  As such, contrarians are on a never-ending quest to find and cultivate great sentiment indicators.  These sentiment indicators are designed to reflect the popular emotional state of the majority of market players at any moment in time, enabling contrarians to consistently bet against the groupthinking herd.


At Zeal we have concentrated much of our recent sentiment research on daily indicators, sentiment proxies designed to reflect the emotional state of the markets on any given trading day.  There is, however, a whole other world of elite sentiment indicators that are not available quite as often as each day.  Although they have a moderately lower resolution and precision than daily indicators such as the VIX and Put/Call Ratio, the weekly sentiment indicators are still extraordinarily valuable to contrarian speculators.


One of the most revered, respected, and oldest weekly sentiment indicators is the famed Investors Intelligence Sentiment Survey.  The Investors Intelligence Sentiment Survey (IIS) was launched way back in January 1963 by legendary analyst and founder of Chartcraft A.W. Cohen and has been published every week ever since.  Today the weekly release of new IIS numbers is such a big event that it is often discussed in real-time on the big financial networks like CNBC.


Mr. Cohen’s original idea was to survey stock-market newsletter writers once a week to see if they were bullish or bearish on the stock markets in the near-term.  Newsletter writers were then and are still today often considered to be “experts” on the markets, rightly or wrongly, so Cohen figured that he could survey these “advisors” and find out when it was best to be long or short the markets.  Before launching his famous survey he originally expected that the best time to be long would be when the most advisors were bullish.


Cohen was surprised to find out that the newsletter writers, just like average investors and speculators, were almost always wrong at major turning points!  His brilliant sentiment survey did indeed yield much fruit, but it worked in the opposite way from what he originally expected.  The best time to go long the stock markets was not when the most advisors were bullish, but when they were bearish!  Cohen’s IIS survey was and is a phenomenal contrarian indicator!


Newsletter writers are mere mortals too, so they are also subject to groupthink and tend to be wrong at turning points.  Like normal investors and speculators, only a fraction of newsletter writers have trained and disciplined themselves to be contrarians so the majority in the IIS survey is almost always just plain wrong at major turning points in trends.  Newsletter writers experience the same deadly emotions as everyone else, and as a group they are just as easily swayed by popular emotions and current stock-market-index activity.


Now please realize that I am certainly not attacking newsletter writers here!  Many of my personal financial heroes are newsletter writers, both past and present, so I too view the really great ones as elite gurus and geniuses.  They have blessed me with countless insights and knowledge for which I am deeply grateful and thankful.  They even inspired me to enter this supremely fun business!


But, in writing letters myself now, I fully understand that newsletter writers are just as subject to greed and fear as everyone else, perhaps even more so since we choose to immerse ourselves in the markets constantly.  When folks are kind enough to compliment me or even sometimes accuse me of being a “guru”, I just have to smile, shake my head sideways, and laugh.  I am nothing but a mere student of the markets, and if I lived for a dozen lifetimes I could never learn all that I want to know about how and why the markets work!  Writing newsletters is all about perpetually learning and growing.


Many newsletter writers I know feel the same way.  They have a deep passion for what they do and they are very thankful to actually earn a living by perpetually deepening their own understanding of the markets, of investing, and of speculation.  Yet, they never reach a point where they consider themselves gurus, they are constantly observing, analyzing, learning, and adapting over many decades.


The IIS survey is so valuable because it gathers the views of a wide variety of respected newsletters and neatly summarizes them into a few numbers each week.  The good folks at Investors Intelligence gather countless newsletters and then carefully read them to determine whether a newsletter writer has a bullish, bearish, or neutral bias in any given week.  If an advisor is telling clients to buy the letter is considered bullish, and if an advisor is telling clients to sell it is considered bearish.


These Investors Intelligence editors who actually read the letters are very good, and I have heard that there have only been less than a half-dozen editors in the entire four-decade history of the IIS survey so consistency is extremely high.  They prefer to rate letters as either bullish or bearish, but if a particular letter is vague enough it is simply considered neutral as a fallback position.


Investors Intelligence then collates the results of this survey exercise once a week and publishes it every Wednesday for its clients.  Investors Intelligence offers some fantastic services for investors and speculators and I highly encourage you to check out their excellent website at for more information on their valuable services and their venerable sentiment survey.  I would also like to thank the great teams at Chartcraft and Investors Intelligence for sharing their outstanding sentiment survey with the world!


It is perhaps easiest for us as speculators to understand the implications of the IIS survey by looking at some charts.  Our first chart this week is the weekly results of the Investors Intelligence Sentiment Survey since 2000, encompassing the entire Great Bear to date.  The percent of bullish advisors is graphed in green, bearish in red, and the remaining neutral group in yellow.


The weekly S&P 500 is superimposed on top of this IIS data in blue so we can observe how the survey really works as a marvelous contrarian indicator.  The powerful contrarian nature of advisor sentiment is quite striking.



So far in this Great Bear market, just as in the entire history of the IIS survey, newsletter writers as a whole have done a remarkable job of missing virtually all the major tops and bottoms!  While there are always some really exceptional and good contrarian newsletter writers who get it right, the majority of newsletters surveyed by Investors Intelligence seem to be greedy when they should be scared and scared when they should be greedy.


The overwhelmingly contrarian nature of this sentiment indicator is most apparent when one analyzes the weekly readings in light of the actual S&P 500 stock-index performance shown in the graph above.  So far in this post-bubble bear market, there have been four major bounces at new bust-to-date interim lows.  They occurred in April and September of 2001 and July and October of last year and are readily evident above.


It is fascinating, maybe even a bit frightening, that the majority of newsletter writers always happened to be most bullish as a group at exactly the wrong times, right before major downlegs to new bust-to-date interim lows ensued.  Every major peak in the green percent of bullish advisors line above occurred just as the markets were on the verge of breathtaking waterfall declines to fresh new interim lows.  These sentiment tops have occurred in the past whenever the IIS bullish advisor reading approached or exceeded 55% or so.


Unfortunately the same story happened on the bearish side of the game as well.  Whenever the red percent of bearish advisors line exceeded 40% or so, it was right at or slightly after a major interim bear-market low!  Newsletter writers, like the majority of investors and speculators, happened to be the most bearish right around major new lows at the very moments that massive bear-market rallies were erupting out of the short-term ashes!


Just as the father of the Investors Intelligence Sentiment Survey A.W. Cohen noted decades ago, the majority of newsletter writers, the very folks widely perceived as being “experts” or “gurus” by many investors and speculators, were just as wrong about the turning points as everyone else.  Being a newsletter writer myself these days, this is sure a humbling revelation!


The power of the IIS survey as a contrarian sentiment indicator is amazing.  If you examine these charts, you will note that the same relationship holds.  Newsletter writers surveyed by Investors Intelligence as a group are most bullish at interim tops and most bearish at interim bottoms.  As speculators we have to bet against the majority of these folks!


Contrarian speculators today need to take careful note of this week’s IIS survey results, released Wednesday, which reflect what the IIS newsletter writers were thinking last Friday.  The percent of bulls soared up to 56% while the bears plummeted to under 21%!  It is extremely provocative to note that the percentage of bearish advisors hasn’t plunged any lower since February 1992, over a decade in the past!  As of the end of last week, only a fifth of the newsletter writers remained bearish!  As a contrarian indicator, the lack of bears is a very bearish omen!


If the IIS survey proves true to form this time around as it has so many times in the last four decades, we are on the verge of a sharp decline in the US stock markets in the coming weeks and months.  As a contrarian speculator playing the short side who has been hammered pretty mercilessly by the war rally, I am very encouraged to see the IIS once again reaching extremes suggesting a short-term trend change is imminent.  With most of the advisors bullish and very few bearish, odds are another short-term interim top has already been achieved.


This week I was talking with a good friend of mine and fellow newsletter writer Dr. Harland Hendrickson about this latest fascinating IIS survey.  Dr. Hendrickson and his fine team have published the excellent “Market Trend Follower” newsletter for almost 15 years now, and his company Hendrickson Financial also offers excellent private portfolio-management services.  Dr. Hendrickson is a brilliant contrarian investor and I have long enjoyed drinking in his great wisdom on the markets.


Dr. Hendrickson has a special interest in the IIS survey since his newsletter has been one of the letters actually included in the survey for about a decade now.  This week I asked him what he thought of the low bearish readings.  He was gracious enough to allow me to publish his response, which is fascinating and offers some great insight into the thoughts of an actual surveyed newsletter writer watching the IIS survey unfold…


“It has been about 10 years that Investors Intelligence has been receiving my monthly newsletter centered on financial markets and more recently a weekly email.  I have come to believe that those of us that are still publishing (a number have fallen by the wayside the past 3 years!) may have gotten smarter over the years, but now the excessive Bullishness this week makes me wonder, maybe most of them have not wised up!  My clients are 100% in cash, except for some Gold.”


“We realize that when the percentage of Bearish advisors increases to a larger percent than the Bullish advisors, we look for evidence in our timing systems that will give us an early Buy signal.  Then when the reverse is true like now, we will be looking for an early Sell signal.  Investors Intelligence Advisor Sentiment Indicators worked very well through the end of the 1994 Bear Market.  Since then, the percentage of Bullish advisors has only occasionally been less than Bearish ones.  This worries Michael Burke and John Gray of Investors Intelligence after 3 years of the worst Bear market in 70 years.  Will using this Contrary Indicator work again this time?  If it does, a lot of newsletter writers will have missed it again and I will have to retract my statement about them possibly wising up!”


Dr. Hendrickson humorously points out that sooner or later newsletter writers as a whole ought to wise up!  It is indeed remarkable that for four decades the majority of newsletter writers as a group have still been swayed by the same popular extremes of greed and fear that trap general investors into making the wrong trades at the wrong times.  Since newsletter writers are blessed to be able to study the markets full time, they ought to know enough about contrarian investment and speculation theory to fight the crowd rather than run with it.


Focusing back on the task at hand for contrarian speculators, actually interpreting IIS survey charts in real-time, it can get complicated trying to define trading rules based on the ever-changing bullish and bearish advisor numbers.  For example, today should we place more weight on the extremely low bearish advisor reading or more weight on the high but not-yet-as-close-to-record-levels bullish advisor reading?


One potential solution to interpreting this data in real-time is to mathematically distill the bullish and bearish numbers from Investors Intelligence into a single easy-to-analyze ratio.  By dividing the percent of bullish advisors by the percent of bearish advisors, we arrive at the Investors Intelligence Bull/Bear Ratio, or IIBBR.  This grants us a nice single graph line to compare to the stock markets and interpret, which greatly simplifies the analysis of the awesome data provided by Investors Intelligence.


Our final graph this week shows this IIBBR graphed under the S&P 500 in the Great Bear market to date.  The extremes in this ratio have been remarkably consistent since the late 1990s, a great sign.



The Investors Intelligence Bull/Bear Ratio conveniently summarizes the essence of the IIS survey each week.  The ratio is also easy to interpret by itself.  A level of 1.0 simply means that the percentages of bullish and bearish advisors are equal, while a level of 2.0 means that there are twice as many bulls as bears.  Since the majority of newsletter writers as a whole are remarkably adept at being bullish and bearish at exactly the wrong times, as speculators we want to go long the markets when this ratio is low and short the markets when this ratio is high.


All the major long signals above, turning points in the IIBBR, occurred around levels of 1.0 or lower.  Anytime the ratio smashes through this 1.0 line, speculators should examine other indicators and consider deploying capital into long plays and call options for a coming rally in the markets.  As the graph above shows, the low points in this ratio tend to occur slightly after major interim lows in the S&P 500, just in time to catch the latter two-thirds or so of the inevitable negative-sentiment-spawned reaction rallies.


These ratio bottoms slightly lag actual stock-market bottoms for two primary reasons.  First, the actual IIS survey data is released on Wednesday, but it reflects results from the prior week.  It does take a considerable amount of time, of course, for the Investors Intelligence editors to read the surveyed newsletters and collate the results.  This process accounts for a week of the lag seen above.


Second, since the majority of newsletter writers don’t play the contrarian game well, they don’t tend to shift away from sentiment extremes until after the stock indices have given them a concrete reason to shift.  Rather than being contrarian and anticipating trend changes based on unsustainable sentiment extremes, the majority of the surveyed letters will not shift their biases until a week or two after the markets have already turned, hence the lag in the indicator.  This is the “I’ll only believe it when I see it!” school of momentum investing!


On the short-side of the game, extremes of bullish sentiment tend to occur above 2.0 in the I.I. Bull/Bear Ratio.  As you will note in the chart above, since the Great Bear began in mid-2000 every time that newsletter writers have become overwhelmingly bullish the stock markets have plunged not too long after.  The financial markets will not tolerate extreme greed or extreme fear for too long, and newsletter writers as a group are just as likely as anyone to get too greedy or too scared right alongside general investors near major tradable turning points.


So, trading the I.I. Bull/Bear Ratio is pretty straightforward.  When the ratio plunges under 1.0, odds are a short-term rally is approaching so it is best to consider closing out one’s shorts, selling any remaining puts, and throwing long as well as buying call options.  These long positions can be held until the ratio blasts back above 2.0 in the following weeks or months.  Once it soars above 2.0, it is time to consider closing out one’s longs, selling any remaining call options, and throwing short as well as deploying some fresh new puts positions.


Contrarian speculators will note with great interest that the ratio today has gone stratospheric, soaring to 2.68 and its highest level since early 1992!  Let the Longs beware!


While there are some absolutely phenomenally gifted contrarian newsletter writers out there, as a whole the majority of newsletter writers surveyed by Investors Intelligence tend to be as hopelessly inept at picking major turning points as anyone else.  When the newsletter writers surveyed by Investors Intelligence get greedy and too bullish, speculators ought to short the markets.  When the same newsletter writers get scared and too bearish, speculators should throw long the markets.


Now that I have exposed the remarkably bad track record of the majority of newsletters in picking turning points, I can’t resist plugging my own letter, Zeal Intelligence!  I write it for fellow contrarian speculators who are not afraid to short the greed and go long the fear of others.  We track many sentiment indicators for our subscribers, and the current May issue discusses almost a dozen of the best daily sentiment indicators that contrarian speculators can use in their own trading.


Perhaps someday a new breed of newsletters such as our own that remain zealously focused on sentiment can turn the tide and successfully play the contrarian side of the game!


Adam Hamilton, CPA     May 23, 2003     Subscribe