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Purified Sentiment Indicators For The Stock Market

New amendments signed into law in August 2003 provide greater protec- tion to people who invest their hard-earned money and, all too often, find they are victims of unscrupulous con-artists.The amendments target indi- viduals who use false financial statements to induce people to invest their money. They also make it a violation for employees of brokers and advisers to engage in unethical behavior and to fail to maintain records and docu- ments required by law. In addition, the amendments allow the appointment of special agents to exercise police powers against those committing finan- cial crimes, and also strengthen the chances of returning investor assets to defrauded investors by including. | Purified Sentiment Indicators For The Stock Market By David R. Aronson adjunct Professor of Finance Baruch College Hood River Research Inc. John R. Wolberg Professor of Mechanical Engineering Technion Haifa Israel POB 1809 Madison Square Station New York New York 10159 0 Purified Sentiment Indicators for the Stock Market Abstract We attempt to improve the stationarity and predictive power of stock market sentiment indicators SI by removing the influence of the market s recent price dynamics velocity acceleration volatility . We call the result a purified sentiment indicator PSI . PSI is derived with an adaptive regression model employing price dynamics indicators to predict SI. PSI is the difference between observed SI and predicted SI normalized by model error. We produce PSI for the following SI CBOE Implied Volatility Index VIX CBOE Equity Put to Call Ratio PCR American Association of Individual Investors Bulls minus Bears AAII Investors Intelligence Bulls minus and Bears INV and Hulbert s Stock Newsletter Sentiment Index HUL . All SI series are predictable from price dynamics r-squares range from .25 to .70 . Using crossvalidation we derive a signaling rule for each SI PSI and price dynamics indicator and compare them with a random signal in terms of their out-of-sample profit factor PF trading the SP500. Purification generally improves the stationarity of SI by reducing drift and stabilizing variability. However it generally reduces PF for PCR AAII INV and HUL suggesting at least some of their predictive power stems from price dynamics. In contrast PF of VIX is significantly enhanced by purification implying it contains predictive information above and beyond price dynamics but which is masked by price dynamics. Purified VIX is superior to all other indicators tested. I. Background A. Sentiment Indicators Technical analysts use SI to gauge the expectations of various groups of market participants predict market trends and generate buy sell signals under the .