Forex Truth: Smart Rich People Think about Trading Sentiment
There is a certain category of traders called sentiment-oriented. They usually use various methods to evaluate the market sentiment and apply fundamental and technical methods to predict where the market could go soon.
Forex trading is a domain that often creates great opportunities for the informed traders to make their moves be ahead of the competition and gain better profits.
This is especially true for the day traders who usually try to “catch” the market in a specific favorable position for a profitable trade.
What Is Trading Sentiment
The vast majority of experts have a different name for this metric — a market sentiment. This is the term used by Investopedia and other respectable sources.
Market sentiment is a way to describe the current “mood” in the market taking into consideration ALL traders that participate or may want to participate in buying or selling a specific asset.
The complexity of this type of evaluation is what makes it difficult for the inexperienced traders to use this method. In order to understand how most of the uninformed active traders and valued traders will react to a specific tendency in the market, one needs to apply various techniques of analysis.
Most sentiment-oriented traders use both fundamental and technical analysis to perform a proper evaluation of the market situation.
Sentiment is a weighted opinion on the desires and fears of the relevant investors regarding a specific asset.
Traders comply with a specific set of actions when they try to use the market sentiment to form a strategy for the day. In general, this is a very simple pattern.
Here is an easy example:
- Choose an asset and try to predict where the market will go.
- Depending on the state of the asset and other factors, decide whether the asset is overbought or oversold.
- Make your move quickly before other traders start acting in order to gain better profits.
The tricky part is the second step where you should understand whether the market is bullish or bearish. This is a priority task for any trader. You need to understand how the most influential group of investors feel about the asset.
This is why some experts say “fear sentiment” instead of the “market sentiment”. Investors are afraid to lose money when the market starts moving. Predicting when the movement starts and knowing its direction can give a trader that small edge to start selling or buying before others start doing it.
Fundamental Components
In the Forex trading, the base of the market sentiment is always the fundamental analysis centered around the recent news and current political and social environments across the globe.
There are several important factors that define a general trend.
Here they are:
- Economic health evaluated in accordance with GDP, unemployment rates, and other major metrics.
- Social and political events that may change the value of the asset.
- Legislative changes and releases of the new products that also can affect the market.
When learning how to trade Forex, you need to teach yourself to compare various parameters and evaluate the intensity of the possible market changes in reliance on the available data.
This process should be like a habit. Whenever you start thinking about opening a deal, you must perform some basic analysis.
Fundamental analysis helps to identify the general mood of investors quickly. Usually, a current situation is dictated by positions of the valued traders.
Most of them are conservative traders and begin to act when the market starts moving, meaning that they are going to have a head start.
Evaluating the news and economic metrics will help you to get a good grasp on what is happening in the market.
There are several ways to incorporate these criteria in your overall analysis, but the best way to use your knowledge of the market sentiment is to apply it as a baseline for the further analysis that is performed “technically”.
Technical Analysis
It is never enough to just have a good grasp on the situation. You won’t be able to identify the best moment to enter the market or to understand where to put your “stop losses” and “take profits” in order to maximize your profits.
Some tools that can help you to evaluate the state of a certain asset quickly:
- CBOE Volatility (VIX), or notorious fear index, is based on the option market that basically shows how investors feel about the current market situation. Big number of the insurance contracts create too much fear in the community which means that the asset may start moving in the opposite direction soon.
- High/Low Sentiment Ratio. This is an indicator that can be used to estimate whether the asset is oversold or overbought. It compares the amount of stocks/pairs that are being traded at highs to the amount of stocks and pairs that are being traded at lows over a specific period of time (usually, 52 weeks).
- Bullish Percentage is a point and figure chart analysis that allows you to identify the amount of stocks with the bullish sentiment. Normalized markets obviously have about 50% of assets traded with the bullish patterns. When this metric goes up to 80%, traders assume that the market is overbought.
When you need to localize the analysis and apply it to a specific asset, you will have to use various indicators to identify how investors feel about it. There are many techniques that are useful for it.
Usable Market Indicators
If you have identified the market sentiment, you will need to go further and start analyzing each separate asset you want to trade.
It is impossible to cover all available techniques and methods in a single article, but we will give you a list of indicators that can be quite effective when it comes to analyzing the trends.
- SMA. Simple Moving Average is one of the best instruments to identify the trend and probability of the reversals quickly.
- Alligator. This is basically a set of SMAs combined in a visually comprehensible way to give you a clear representation of the current trend.
- RSI. Relative Strength Index shows you whether the market is overbought or oversold. It is one of the simplest yet usable indicators available for traders.
- MFI. Money Flow Index is one of the best indicators for analysis and it mirrors RSI in many ways. However, it can be used as a great complementary instrument.
- OBV. On Balance Volume is another technical indicator that helps you to see when the market is overbought or oversold.
Any great successful strategy utilizes several indicators at once to present a good idea of what is currently happening in the market.
If you want to be amongst those who make the first move, you will need to apply them to the asset quickly and use the obtained information effectively. You can learn about other indicators on Investopedia.
How to Use Market Sentiment
Market sentiment can be used to evaluate future deals. The process involves several points that will lead you to a specific decision.
Follow these steps:
- Make a general assessment of the market situation.
- Confirm or disprove the assessment.
- Make a quick decision on whether to open a deal or not.
Understanding the nature of the market is the first step. Market sentiment is just a way to express how the investors behave at any given moment of time.
By using external tools like CNN’s Fear and Greed indicator or NAAIM Exposure Index, you can get a good overall understanding of the current trends.
The next step is confirmation of your assessments through the careful analysis of the market. It is a moment when you apply various technical indicators to the chart and start thinking whether your assessment of the situation is relevant.
Trading sentiment should be only a small fraction of a strategy when it comes to the Forex trading. In fact, most of the sentiment-oriented strategies often lead you to riskier decisions in comparison with more conservative approaches.
Most sentiment-oriented traders try to predict possible price movements and get on board before the valued traders change the sentiment by moving large quantities of the asset. The overwhelming majority of traders prefer more conservative trading methods.
Downsides of Market Sentiment
By evaluating emotions and fears of other investors, you can make a very good near-intuitive decision that can truly bring you a sizeable profit.
However, the risk is also quite high. No one knows where the market will go at any given moment of time.
Those predictions are often wild guesses based on what an individual trader thinks about the community of investors in general.
Such an assessment can be wrong or too subjective. If you look at the technical analysis loosely enough, you will notice that any theory about the market condition can be backed up by some indicators.
Another big problem is that you cannot really predict how the valued traders will behave. Many of them are so-called informed traders who are just waiting for the market to start moving. They do not rely on guesses and can significantly affect the price.
All these points add uncertainty and make each trade very risky. If you do not have enough money to make such risky moves, you should consider staying away from the decisions dictated by how you understand the market sentiment.
However, you should always monitor the market and create a good Forex trading system that would incorporate market sentiment to a certain degree. If you notice an opportune moment to start a potentially profitable deal, do not miss your chance.
Trading Currency Pairs and MS
Those investors who trade currencies are very much affected by the market sentiment. The amount of individual valued traders is not that huge to make a big difference.
It means that the MS assessments that are based on lots of factors and explained through the proper analysis, often result in reliable deals.
Currencies are still bread and butter of Forex despite the fact that many traders are offered CFD contracts and trade futures.
Currencies are volatile and offer you a good opportunity to use both fundamental analysis and technical analysis to check whether your assessment of the market sentiment was correct.
How to Stay in Touch with the Market
Don’t forget to check the news regularly. You can find a great article related to the news trading on our website.
News can often shift the balance in a stagnant market and become that last straw that breaks the camel’s neck.
Your typical behavior pattern should look like this:
- Analyze the market with the general MS indicators.
- Identify the assets that are possibly overbought or oversold.
- Wait for the news and monitor the upcoming financial events to see when a trend change can happen.
- Spend time on the research and preparations.
- Make decisions ahead of the market and take profits in time.
Analyzing the market on a daily basis should become your second nature if you want to be a successful Forex trader. You must wake up and start checking the news and states of various assets.
Identifying the market sentiment for each of your favorite markets is quite important.
When MS Is Most Valuable
Market sentiment should be used mostly in the highly volatile markets where the amount of uninformed traders susceptible to opinions and sudden moves is higher.
This is where the fear and greed start creating conformity and make it easier for a good sentiment-oriented trader to make the efficient moves.
Market sentiment should be used in the Forex trading for the currencies that are usually not that volatile and have the identifiable long-lasting trends.
The Main Takeaway
Market sentiment is a very important tool that can be used to your advantage. However, you should be always aware that the market is very flexible and dangerous.
You need to use MS to complement your strategy. Do not build your whole trading system on the market sentiment alone!
Try It Yourself
Trading psychology is one of the essential pillars of the Forex success, so even if you are an experienced trader, you shouldn’t dismiss a trading psychology advice.
Do you need a comfortable space in order to take control over your emotions and get prepared to the live trading?
Simply download Forex Tester for free. In addition, you will receive 22 years of free historical data (easily downloadable straight from the software).
Grow your patience, boost your trading skills, learn to avoid psychological traps without drawing your live account.
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