Investor Sentiment, Market Timing, and Futures Returns

Investor sentiment index based on actual trader positions is useful for forecasting S&P 500 index futures returns. We find that large speculator sentiment is a price continuation indicator, whereas large hedger sentiment is a weak contrary indicator. Small trader sentiment does not forecast returns. We show that extreme levels and the combination of extreme levels of sentiments of the two types of large traders may provide a more reliable tool for forecasting. Our result suggests that large speculators may be associated with superior forecasting ability, large hedgers behave like positive feedback traders, and small traders are liquidity traders. Our further empirical evidence is broadly supportive of this contention.