When most investors are fearful, it pays to get greedy. But even if you can follow through on that advice, what many people forget is the converse: When you find greed throughout the stock market, it's time to start pulling back and wondering what the next shoe to drop might be.
Investor sentiment has long been an indicator that smart market players bet against. Now, one clear measure of where we are on the fear-greed spectrum shows regular investors as optimistic about stocks as they've been since before the March 2009 market bottom -- and the result could be devastating.
Short interest and you
Even among sophisticated investors, selling stocks short isn't a run-of-the-mill strategy everyone uses. In order to use it, you have to get clearance from your broker, along with the margin capacity to sustain your short trades. More important, you have to be willing to accept the theoretically unlimited losses that shorting entails, accepting instead the maximum 100% gain you could earn if the shares you short drop to zero.
But when you add up all the short-selling activity in the market, you get an interesting barometer on the general attitude toward stocks. And according to findings from Strategas Research Partners, the level of short interest on the New York Stock Exchange is currently nearing its lowest levels in the past three years -- suggesting that most investors believe there's no money to be made by betting against a bull market.
You can see the same trend in certain stocks that got beaten down last year. AuRico Gold
Elsewhere in tech, JDS Uniphase
Look out below?
But the problem with the disappearance of short-sellers is that bulls have already used up any catalyst that short-covering activity would generate. In other words, if the companies can't now deliver on the promises they've made, then a relative lack of short interest will require bears to take on new positions, thereby pushing prices down further.
Of course, short interest isn't a perfect contrary indicator by a long shot. Travelzoo
Short-term indicators are notoriously imprecise, and a bearish contrary indicator doesn't tell you exactly when a correction may come. What's clear, though, is that sentiment has grown a lot more favorable toward stocks lately. If you can't afford to suffer through another market drop, now's the time to look at whether the risk level of your portfolio matches up with your temperament.
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