An important aspect of trading has to do with where other traders believe the market is heading. These sentiments are traditionally measured by taking polls of selected groups of investors, advisors, investing individuals and professionals. But of course, there are usually some problems associated with this methodology: (a) Many polls are taken over a period of several days, during which time market movement and investor outlook can change radically, and ( The responses are strictly subjective, reflecting the emotional status of the person being polled, not necessarily his/her investment position.
The idea behind using sentiment indicators is that we are trying to determine when investors have reached a "saturation point" of bullishness or bearishness. Tops are formed when everybody who is going to buy has bought, and bottoms occur after there is no one left to sell, but this is difficult to reflect in a simple poll.
The first Rydex Ratios were originally based upon only two very small mutal funds, URSA (bear) and NOVA (bull). But since then, new funds have been added by Rydex, with over 20 funds with assets well approaching $7 billion. This is a very stable platform from which to derive indicators.
Rather than measuring someone's vague opinion about market direction, the Rydex Ratios present specific information about where people are actually putting their money. We look at the reationships between the assets flowing into Bull, Bear, and Cash funds in order to evaluate not just what people say their sentiment is, but what they are actually doing.
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