Using AAII Sentiment As A Buy Signal

Includes: SPY
by: Paulo Santos

Among many other sentiment tools available in the market, like the daily sentiment or put/call ratios, one stands out as giving reliable buy signals over time.

That is the AAII Sentiment Survey (AAII stands for American Association of Individual Investors). AAII conducts a weekly survey of its member’s sentiment, and publishes the results in their site. This survey has produced good contrarian signals when at extremes in Bearishness.

These extremes can be calculated by taking the Bullish % and dividing it by (Bullish % + Bearish %). When this ratio goes below 0.30, it provides a reliable entry point in the market, good for a strong rebound during bear markets, for a continuation of a bullish trend during weakness within a bull market, or for a reversal from bear to bull markets. In any instance, it provides a tradable signal to the long side, with 100% accuracy over the years.

Unfortunately, in the present correction it came close to providing such signal, but never really got there. Anyway, it is a very helpful indicator during sell-offs to provide a good and safe entry point, and as such it should be on every trader’s toolbox.

The data to build this indicator is available through this link, with historical data available here.

It is also possible to use the indicator to produce sell signals, however they are much less reliable, so should be seen merely as a “caution” guide when the ratio goes over 0.60. It can go much higher, though. Such a signal was activated on the 27th of October, when the ratio hit 0.63.

Here's the recent behavior (click to enlarge image; the green vertical lines represent the buy signals).

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.