What is the speculation index?
The speculation index is the relationship between the trading volume on the United States Stock Exchange (AMEX), now known as NYSE American, and that of the New York Stock Exchange (NYSE). A high level for the index may indicate increased speculation among traders, as NYSE American lists smaller, riskier stocks.
Since high levels of speculation occur during bull markets, the speculation index is therefore considered a leading indicator of market activity and sentiment.
- The speculation index is a measure of the trading volume of the stock market, which compares the trading relationship between the NYSE American and the New York Stock Exchange.
- It is calculated by dividing the total trading volume of the US NYSE stock exchange by that of the NYSE.
- The speculation index is based on the assumption that the small-cap stocks that make up the NYSE American are riskier, on average, than the large-cap stocks on the NYSE.
- The speculation index is a proxy for the amount of speculative trading activity in the US equity markets.
Understand the speculation index
The speculation index is calculated by dividing the total trading volume of the NYSE US Stock Exchange by the total trading volume of the New York Stock Exchange. It is often expressed as a percentage. The higher the percentage, the higher the speculative activity.
The basic assumption behind the speculation index is that the New York Stock Exchange is made up of relatively mature blue-chip companies, while the American New York Stock Exchange contains smaller companies that are presumed to be riskier for investors. For this reason, proponents of the speculation index argue that greater investment in US companies on the NYSE compared to those on the NYSE represents more aggressive risk-taking by investors and is therefore an indicator. the level of speculative trading activity in the US equity markets.
Why is speculative activity important? Because it is generally associated with an optimistic sentiment among traders and investors, causing share prices to go up. Some analysts believe that a high speculation index means optimism on the part of investors. However, if the index rises too high, it may indicate that the market is approaching its peak and the beginning of the end of the bull run.
Criticism of the speculation index
Critics of the speculation index point out that since the components of the NYSE and NYSE American change over time, it can be difficult to determine how speculative the components of each index are at any given time.
Furthermore, the speculation index does not take into account the fact that an increasing percentage of the trading activity on both exchanges consists of high frequency trading strategies (HFT). Because these strategies seek to exploit minute price fluctuations rather than investing based on perceived misjudgements over the medium to long term, the logic that US NYSE investors are on average more speculative than those on the NYSE may have less. merit than in the past.
Real world example of the speculation index
Some investors have developed alternative techniques to measure market sentiment, which circumvent the limitations of the speculation index. A notable example is the version presented by financial writer / podcaster Jesse Felder on his website, The Felder Report.
In a report published in February 2018, Felder presented what he called a “different index of the volume of speculation.” He offered a series of charts demonstrating how investors’ use of margin debt has exploded in recent years, even surpassing the level reached at the peak of the now infamous dot-com bubble. Their data also revealed a negative correlation between margin-based trading levels and subsequent three-year stock market returns.
Although this methodology differs from the traditional speculation index approach, it supports the widely held view that a large number of speculative trades indicate that the stock market may be approaching its peak.