Our research strongly suggest that volatility in market psychology correlate to market crashes. In our last post we noted a dramatic jump in SentiTrade’s volatility index (V-SQ). The calculation shows how frequent the market news swing from positive to negative, and back again. Since our last post the DAX lost more than 400 points… in the same period, the V-SQ continued to make significant gains (see illustration below).

As opposed to the VDAX (the volatility calculation of the DAX itself), which uses an implicit approach, SentiTrade measures historical volatility. A simplified way of explaining the difference, is to say that the implicit calculation accounts for the expected volatility which occurs when future contracts are about to expire. SentiTrade on the other hand, compares the historical range of positive vs. negative financial news stories, to the current situation. Market psychology is then assessed directly at the source, namely in financial news stories. Currently, there are signs that the correction will continue and that we’re approaching a market psychology meltdown:

TheV-SQ now stands at 95%, normal levels move between 50% and 70%. The last time SentiTrade measured levels in this area was August last year. Our all time high level of 108% dates back to August of 2008, one month ahead of Lehman.

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