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<h2>Identifying Market Reversals with Investor Psychology</h2>
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<p>It is widely known that extremes in investor psychology often marks key turning points in the stock market.  Unfortunately, most of the widely accessible gauges of investor sentiment are unsuitable for long-term investors due to their high volatility and limited historical track records.  To correct for this problem, we developed our own longer-term measure of investor psychology called the InvesTech Investor Psychology Barometer (IIPB).  Our IIPB contains five historically reliable components that are complementary in nature, and therefore provides reliable signals when investor sentiment reaches an extreme.</p>
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<p>Investor psychology can reach extremes in two ways: extreme optimism or extreme pessimism.&nbsp; Readings of extreme optimism in our IIPB typically precede market consolidations or bear markets, and such high readings usually warrant a degree of caution given that stocks are vulnerable to a pullback.&nbsp; On the other hand, readings of extreme pessimism indicate that selling pressure is nearing exhaustion and that a buying opportunity is likely at hand.&nbsp;</p>
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<p>Both types of extreme readings, however, should be put in context of the surrounding technical and macroeconomic evidence.  For instance, if our other indicators remain on solid footing while the IIPB reaches a reading of extreme optimism, it is likely that the next pullback in the market will be a mild correction.  On the other hand, if the majority of our indicators are weakening precipitously while the IIPB is showing extreme optimism, there is a strong likelihood that a deep correction or a bear market lies in wait.  In short, our IIPB is best able to identify market reversals when it is used as a part of a weight-of-the-evidence approach.</p>
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