Welcome back to our last lesson on Market Analysis! Today we discussing Market Sentiment Analysis and how the personal opinion of traders can shape the markets!
What is Market Sentiment?
It is an approach where traders opinions ( incl. views, ideas, opinions, feelings, psychology, emotions, etc.) are taken into the account to explain the current direction and price movement of the market! It is used to alert traders about extreme conditions and upcoming price reversals!
Forex Sentiment analysis is used to identify positions taken up by other participants of the market to determine their own trading decisions.
Market Sentiment is most typically described as either bearish or bullish. The bearish sentiment means that the prices are going down, while bullish sentiment indicates prices going up. Once identified, traders can decide whether to go with or against the majority of the players.
Going against the market sentiment usually indicates that the trader is following a contrarian trading strategy. A strategy where traders anticipate a shift in the market sentiment and place their positions (buying in a bearish market & selling in a bullish market) hoping to catch a reversal as they begin. Contrarian approach can lead to a very high risk to reward ratio when the reversal is caught.
However, it also carries an increased danger of trading against a trend that might be stronger than anticipated and traders will hit their Stop Loss levels as the trend continues.
What about Indicators?
Volume traded is most commonly used as an indicator when trading stocks and options. However, as we know by now, Forex Market is de-centralized and traded over-the-counter! As such, we are unable to measure the volume of each currency pair easily. But there certainly are some tools that we can use to try and better gauge the market sentiment when analysing the markets!
Let's discuss two indicators that can be very useful when trying to better understand the market sentiment:
Broker Forex Sentiment Indicators - these indicators provide clients with the overall long and short positions held by clients of the particular broker only. It is a useful tool when analysing the markets but traders have to always remember that the displayed sentiment ratio may not represent the wider picture. These indicators are only limited to the positions held with the broker. These may also be limited to only a handful of most trader pairs. As such, to better understand the bigger picture you would have to combine information provided from various brokers!
Broker Sentiment Indicators can be an effective contrarian indicator as it is not uncommon for retail traders to trade against new and developing trends hoping to catch the reversal.
The Commitment of Traders Report (COT) is the tool that is the most widely used by traders when looking to analyse the market sentiment (and its extremes). This report provides us with a better understanding of the futures market (considered as 'the next best thing' as there are no better tools for the 'spot' FX market). It is published every Friday around 2.30 pm EST (7.30 pm BST) by The Commodity of Futures Trading Commission (CFTC). You can access the report here!
The report measures the net long and short positions taken by the three main groups of traders:
Commercial (Hedgers) - may include banks, large multi-national corporations, manufacturers, agricultural producers, etc. All with commercial hedging interests to protect themselves against any unexpected price movements that would negatively affect their operations. Their main goal is price stability and not to profit from speculations.
Non-Commercial (Large Speculators) - may include large speculators, financial institutions, banks, hedge funds, etc. They trade with large volumes of future contracts and are interested in making profits from their speculation. These traders do not hedge to protect their assets.
Non-Reportable (Retail Traders) - includes all smaller speculators (such as retail traders) with limited capital who are also trading to profit from their speculations.
Most traders agree that The Commitment of Traders Report is best used as a medium to long-term indicator!
Now that we have briefly discussed three main types of Market Analysis, you can see the importance of each approach and how your trading can benefit from combining them all! A better understanding of the markets with technical, fundamental and sentiment analysis may bring new trading ideas, more precise entries and better management of the open positions!
We hope that you've enjoyed our lessons so far and that you will join us next week! We will discuss a Trading Plan - the most important document that every trader should have and follow every day! Make sure you don't miss it!