12 Keys to Trading Earnings for Profits

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#6 Investor Sentiment

So what is sentiment and why is it so important?  Investor sentiment is simply the collective feelings and actions of those in the market.  We've found that the most-accurate sentiment indicators generally reflect what investors are actually doing (what they're buying or selling) rather than what they're feeling and saying (poll results), although both have validity in our analysis.

We've all seen a stock drop in price despite an earnings report that met or even beat expectations.  Or one that rallies furiously after merely meeting expectations.  Why does the stock seemingly move against the fundamentals?

Two kinds of investor sentiment usually lead to stocks moving against the fundamentals:

• Excessively Bullish Sentiment:  A stock with relatively low expectations (pessimism) stands a good chance of rallying, as there is plenty of sideline cash available to boost the price.
• Excessively Bearish Sentiment: High expectations (the crowded trade) can put downward pressure on a stock, as there is little to no sideline cash to drive the price higher.  In fact, the path of least resistance for cash is to flow out of the stock, resulting in declining prices.