Market Sentiment in Stock Index Trading

Indices movement is influenced by prevailing market sentiment, which depends on various factors. Common contributors include macroeconomic indicators and geopolitical events.

Economic Outlook and Economic data reports
Monetary Policies - Such as Interest Rates & Inflation policies like Quantitative Easing

Short Term Market Sentiment - Economic Outlook and Economic Data Reports

Certain factors can impact short-term market sentiment, resulting in minor market volatility that typically dissipates within hours or days. Traders can take advantage of these brief sentiments to identify optimal entry points for establishing trade positions.

Take an EU unemployment report as an example. It might reveal a 1 percent jump in the rate. Short-term, this could pull the EURO STOXX index back from volatility. Yet other EU reports point to growth signs. The index should pick up its uptrend right after the brief shake.

Most economic data reports will mostly cause this type of short term market price volatility. The volatility may move the market in any particular direction in the short term, but what matters most is the Economic Outlook. For example if the market outlook for EU Zone is positive economic growth, then the general direction of the EU based indices will be upwards despite the short term market volatility caused by economic data reports.

Long Term Market Sentiment - Monetary Policy

In addition to an economy's overall outlook, which is a primary factor influencing long-term market sentiment for indices, monetary policy also plays a significant role in shaping this sentiment.

The two main components of monetary policy include: Control of Interest Rates and Control of Inflation.

These 2 components determine the economic expansion prospects for a country.

Interest Rates

Interest rates set how much credit people get for business and its price. A 1% rate makes borrowing cheap. Folks take more loans and grow their work with extra cash. A 10% rate limits credit. People have less money for business.

Consequently, for nations maintaining low interest rates, market sentiment when trading their indices tends to be optimistic, as this low-rate monetary policy fosters greater economic expansion.

Therefore the market sentiment for countries that have low interest rate levels will mean that the long-term sentiment for these economies will be bullish.

However, a country with a good economic outlook and high interest rate policy will still have a bullish market sentiment. The low interest rate policy is just one factor among many other factors which influence market sentiment.

Inflation Policy

The decisions made about money in a country are also made to keep inflation under control. The best level for inflation is 2% to 5%.

When inflation drops below 2%, a country slips into deflation. Prices fall so much it can't support growth, and the economy risks slowing down.

Between 2% and 5% - the prices of goods and services at this inflation levels will be at the optimum levels - meaning the price are high enough to sustain economic growth and at the same time these prices are not too expensive to make the goods and services unaffordable to the consumers.

When prices rise above 6%, they start becoming too high and hard for people to afford. As inflation increases, things become more expensive, so people can't buy as much. This means businesses won't sell as many goods or make as much money because their prices are too high for customers. This hurts the economy and can lead to it slowing down because products aren't being sold as quickly.

The art of inflation control is a delicate balancing act, too low and economic growth slows down, too high and economic growth also slows down, and this is why economies have to aim for the optimum inflation of between 2% and 5% to ensure the economic growth of their economy is bullish.

This explains why the inflation policy will decide how the market feels in the long run.

As a stock trader, you may not be aware of the monetary policy of a country, but these policies are critical in shaping long-term market sentiments regarding specific stock indices.

Explanation of Long Term Sentiment Influenced by Monetary Policy

One example of a stock index market that moved because of a money policy is the USA stock index market - DJIA index, which went from 10,000 points to 18,000 points. This was because of the Quantitative Easing (QE) Policy that the FED used after they had also lowered interest rates.

Quantitative easing policy is a monetary policy aimed getting people to spend and at the same time bring inflation levels up to the optimum levels. When FED started their Quantitative Easing program, the American Indices all went up based on this market sentiment - an example is the DJIA index that went up from 10,000 point to 18,000 point.

Simultaneously as the FED began signaling adjustments to its monetary strategy in 2015 by increasing benchmark interest rates, market sentiment underwent a transition, causing stock indices to pause their sustained upward trajectory. The ascent soon resumed after the governing monetary sentiment stabilized, following the temporary shelving of speculation regarding an imminent interest rate increase. All these market movements were directly influenced by the prevailing sentiment shaped by U.S. monetary policy decisions.

Another instance of how monetary policy affects market indices was when the EU Zone introduced its Quantitative Easing program in January 2015 after lowering interest rates several times. This new policy changed the long-term outlook for EU indices to positive, and from January to March, all European indices saw a significant increase and were likely to keep rising even after the QE program began in March.

The EU Quantitative Easing Policy, which will be implemented in 2015 and 2016, will be the key factor affecting the long-term market for all European stock indices. This includes indices like EURO STOXX, Germany's DAX30, France's CAC 40, Italy's FTSEMIB40, Netherlands' AEX 25, and Spain's IBEX 25 Index.

For instance, the Germany DAX30 index rose by 22,000 points from January 2015 when this QE policy was introduced until March 2015 when it began. This shows that for a long time, the market was feeling positive, suggesting that this index would continue to rise and keep a strong upward trend during 2015 and 2016 while the EU's Quantitative Easing program was still active.

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