| Updated: October 23, 2025Market sentiment – the basics
You will learn about the following concepts
- What is sentiment in trading?
- In what way does it influence decisions?
- Informed and uninformed market players
When we talk about market sentiment, we usually refer to the psychology or emotions of market players. Sometimes investors tend to base their decisions on feelings of fear and pessimism, while at other times their psychology is dominated by hope, overconfidence and even greed. As market participants react emotionally to the market, these emotions affect overall market activity.
An example concerning the stock market
The stock market provides an excellent example of what the term sentiment means. If we imagine a bullish market, where stock prices have been surging, investors who have already taken long positions will see the value of their portfolios increase. People who have not yet participated in the market hear that their friends have made money trading these stocks and, not wanting to miss out on similar returns, decide to enter the market. The average investor is confident that the rise in stock prices will continue. This confidence encourages them to commit more money to the market, which in turn pushes stock prices even higher. As more investors open positions, demand for these stocks increases and prices soar. As optimism dominates, stock prices are driven even higher. This optimism eventually turns into overconfidence and even greed, because investors see that their decision has been correct. Being overconfident, players begin to buy stocks irrespective of value. Eventually optimism reaches a peak, while investors have already placed most of their disposable funds in the market. The amount of available money to support further demand for stocks and, consequently, their upward price movement gradually declines. As this tendency deepens, there will eventually be no more funds to support rising prices, so the stock market registers a peak or high.
The opposite scenario is also true. When investors become pessimistic and fear for their investments, they begin to sell stocks. With pessimism taking hold of more and more investors, the number of participants selling the stock increases and this causes prices to decline. Witnessing the falling prices, additional investors begin to fear and sell their stocks as well. Eventually pessimism reaches a peak, while market players have withdrawn most of their funds from the market, and a bottom or low is reached.
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What does sentiment mean?
Sentiment represents the net level of optimism or pessimism among any group of investors, as reflected in an asset’s (tradable instrument’s) or market’s price at a specific point in time. If a stock or commodity is traded at a price that considerably exceeds or falls well below its intrinsic value (which is usually unknown to a trader until some time in the future), the deviation from that value will generally be due to sentiment. It reflects the collective emotion and other intangible factors that arise from human interaction when deciding whether a price is above or below the assumed intrinsic value.
Technical analysts have long upheld the thesis that market prices are actually a combination of fact and emotion. If emotion appears to be excessive and prices deviate considerably from the norm (intrinsic value), a reversal is probably about to occur. For a technical analyst it is of utmost importance to be aware of when prices reflect emotional extremes.
Investors and sentiment
In any market there are generally two types of participants – informed and uninformed. Prices in the market are usually determined by the interactions between these two groups.
The uninformed players are those who act irrationally because they are often driven by their emotions and biases. They tend to become optimistic after a market has advanced and buy, which leads to market peaks, as we saw in the example above. They also tend to be pessimistic during a bearish market and sell, which leads to market bottoms. Uninformed players are usually referred to as ‘the public’; however, even professionals can belong to that group. This is because what makes you an informed or uninformed participant is the timing of your optimistic buying or pessimistic selling relative to market peaks or bottoms.
According to some research, even professionals such as mutual fund managers or Wall Street strategists often display the behaviour of uninformed players.
We can conclude that the majority of market participants are uninformed.
The other group of investors, the informed market players, are those who act in a way contrary to the majority. They tend to sell at market peaks, when the majority is highly optimistic, and buy at market bottoms, when the majority is fearful and selling. Informed players are not necessarily professionals. They can be insiders from a particular company or simply day traders.
The uninformed participants have at their disposal a significantly larger amount of funds than the informed players. Every day the informed players stabilise global markets by taking action when minor anomalies in prices occur, while the uninformed players tend to ‘overwhelm the price action’ with positive feedback. In many cases the informed players are forced to conform to the prevailing emotion.
Because maximum optimism and pessimism occur at price extremes and the uninformed player makes decisions based on emotion, a trader who relies on technical analysis and can determine how each group of investors is acting may gain insight into future price direction. The informed professional may presumably act correctly, while the uninformed public may act incorrectly, especially when driven by extremes of emotion. If a technical analyst knows that the majority of market players are exceptionally optimistic about prices continuing to rise, he or she may conclude that these participants are almost fully invested and that prices are probably nearing a peak.
A trader using technical analysis strives to make investment decisions that are contrary to those made by the uninformed public, and to mimic decisions made by the informed participants.
Sometimes emotional excess can cause an extraordinary increase in prices (bubbles) or an extraordinary decline in prices, also known as crashes or panics. During a bubble, stock market returns, for example, tend to be well above the average return. The occurrence of bubbles is evidence that prices are not always determined rationally. Emotion can dominate the market and send prices far beyond any reasonable value before a reversal materialises.
It can be frightening when most investors cannot perceive reality as it is and their decision-making becomes dominated by greed and other psychological biases.
Behavioural finance specialists attribute some of the biased behaviour of market players to the so-called crowd behaviour, which we discuss in the next article.