I find that measuring sentiment is an excellent guidepost to where we are in a rally. At the July lows almost every indicator and most anecdotal evidence was pointing to excessive pessimism. So where do we stand today?
Yesterday, Rydex traders finally capitulated and turned slightly positive after fighting this rally tooth and nail for four weeks. They are nowhere near extreme optimism but this does tell us that the vast majority of the gains are likely behind us.
In a strong market sentiment will get to excessive optimism and might even stay there for a while. In weaker markets it may never get there. This market has now done the minimum and the most ardent bears might want to take a shot from the short side here but the risk/reward setup is not great.
There is also a time aspect to sentiment. This move higher has lasted about four weeks. I would prefer if six weeks had past as most market participants will capitulate to a trend after six weeks. The bottom line is that for a better risk/reward setup on the short side sentiment will need to become more positive and more time needs to pass. However, if the market is truly weak than this rally has now done the minimum.