Market Sentiment, continued...

The one thing you do not want to see if you are bullish on stocks is a strong consensus that stocks will go up. The crowd is usually wrong, and the bigger the crowd, the more wrong they get. Right now the crowd is getting pretty big. The way I like to explain it to people is this. What is a trend in a financial market? In its simplest terms its people changing their minds from one direction to another. So lets say that the entire stock market is only made up of 10 people. By the time the 10th person buys, prices literally cannot go any higher. There is simply no one to bid prices higher. While this example obviously simplifies the task of determining how many people are committed to one side of the other, there are various measures which one can use to gauge how far along the trend is.

Chart 1: Investors Intelligence Survey
Courtsey of Market Harmonics

Percent bulls is certainly at the highs of the range, and percentage of bearish respondents is quickly drawing near the danger level as well. This is not what the sentiment backdrop would look like if this was the start of a new rally leg, as most are claiming, but in fact the opposite. The American Association of Individual Investors is showing a nearly identical reading, with 53% responding bullish to last weeks poll, 14 points above the historical average.

Also interesting is the last week commitment of traders report for the S&P e-mini. I like looking at the commitment of traders report because one can easily make a direct comparison between large trader and small speculators. Small speculators tend get it wrong, especially at turns, while large traders tend to be positioned correctly.
Chart 2: 

What's interesting here is while most of the sentiment surveys show a bullish consensus, large professional traders have actually accumulated a large net short position in the S&P e-mini. In fact, it's the largest net short position that they have held in over two years, and right before the market took a nose dive in late 2008.