This indicator is used to forecast the short term direction of the FTSE 100 and S&P 500.
The ESI combines both the BTI and 34-day BTI indicators to measure investor sentiment. The position of the ESI depends on the position of both BTI and 34-day BTI. The general rule is:
If 34-day BTI is down AND BTI is down, ESI is bearish
If 34-day BTI is up AND BTI is up, ESI is bullish
If the 34-day BTI and BTI are in opposite direction, ESI is neutral.
34-day BTI divergence
Divergence can be an early warning of a change in sentiment when seen in the 34-day BTI. In general, the 34-day BTI will rise with the market and when the market falls the 34-day BTI will fall too. Sometimes the 34-day BTI will turn down while the market continues to rise, this is known as divergence. This behaviour often occurs prior to a change in sentiment. The last time this behaviour occurred was in early March 2013 prior to the March-April decline.
Each time the 34-day BTI rises above 400, the stock market corrects within a few weeks. The last time the 34-day BTI rose above 400 was on 26 November 2013. The FTSE pulled back and is still trading lower.
From historical data there is enough evidence to suggest that the position of the ESI gives an accurate forecast of future stock prices.
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