Welcome to our Market sentiment article, where we will look at what makes the market turn. Learn about greed, fear, dumb money, and how they all come together to form forex sentiment. In forex trading, you will need to find the best forex broker in the world for you, and that is why you have to read out forex broker reviews.
All forex traders have an opinion about the market. For any trader, it can be bullish or bearish. The market sentiment is the collective feeling of the participants of the market. Forex sentiment is usually integrated into the analyses that we make.
We will find out how the sentiment affects the market and how you can trade it. Each trader has a personal explanation as to why the market moves in a certain way. No matter how convinced you may be that the market will move in a specific direction, there is always something that could change.
There is also a concept called ‘dumb money' where we will discuss some essential details you should know. Forex trading is not very hard when you know what you are doing.
Every guide you have read about how to trade the forex market has told you that you must eliminate emotion from your strategy. Speaking of strategy, they must have said to you that you need to combine the strategies to make everything work properly.
That is all true. But there is a big irony here. The forex market is not able to operate without emotions. That is why we have strategies to use the market sentiment and to be able to read it.
Understanding Market Sentiment
The same way that a game of football draws people and a concert does the same, the consciousness of an individual always turns into crowd thinking. That is why the forex traders tend to create a collective entity of emotions, reactions and moods that we call market sentiment.
First, the FX sentiment is one of the ways that you build a strategy before you start trading. There are fundamental analysis and technical kind. They all remove emotion from the equation. But, since we are dealing with people in the market, we cannot discount their feelings, and that is why market sentiment is the third pillar in making forex trading strategy.
This is a reflection of the market’s mood, and it directly links to the current events in the economy and news of recent happenings. The traders need to know what the sentiment is, as it is one of the necessary skills a forex trader must-have.
When market sentiment takes a turn, you have to move with it and follow the news, data points and economic events that make the currency switch trajectories. To augment how you trade, read our forex broker reviews to find the best forex broker in the world for you.
Some of The Things You Must Factor
You might ask, wouldn't it be better just to trade using logic? Well, first of all, you are not on planet Vulcan, Spock! The world of forex trading is dependent on forex sentiment. Here is why we have to consider the emotions every time that we trade.
- The Sentiments are not Equal
since we have so many data points to consider and events that happen in the FX market within one day, it is not easy to tell very clearly, what will affect the common forex sentiment that we experience.
That is why we have to classify them into minor market sentiment and dominant market sentiment. There is an essential level to every forex sentiment you see.
The recommendation from experts here is to strictly follow the interest rates set by the Central Banks and then ignoring the press releases from retail companies. You must always be aware of both, but you need to know that some carry more weight than others.
- Trade Only Fresh Sentiment
We consider forex sentiments older than 48 hours, to be worthless. If you miss the opportunity when it is fresh, do not get in late. Just wait for the next new forex sentiment to pop up and then trade that—the fresher the market sentiment, the better the fluctuation in price.
Waiting for a retracement is the priority for a trader. Do not just chase the buy or sell prices of the market. Patience will change everything for you.
- Forex Sentiment Traders Must Follow the Bears and Bulls
Even the new traders in the market know that the forex sentiment/emotion can be divided into the optimistic type and the pessimistic type. You can either have traders buy or sell, respectively.
The overall market sentiment is tied to the optimistic and pessimistic trend. There is a small number of traders who are undecided. They do not know whether to buy or sell. You should not be among them unless you are really unsure.
To make money, follow the bullish or bearish trends, as dictated by sentiment analysis, and see what happens. If your analysis is correct, you should make money.
Fear and Greed are Major Emotions
The dominant one of these forex sentiments is the one that will determine the overall sentiment of the market. Most of the investors are conditioned to follow the direction in which the prices go. However, the bullish or bearish mentality has a peak.
Understanding when the peak has arrived is very crucial in knowing when to avoid buying into the market or selling out of it. When the peak faces a downtrend, that’s usually greed in motion and when it is bottoming out before it starts to pick up again, that is fear.
Knowing when fear or greed emerges is very important when it comes to identifying market sentiment. You can know who is selling up as the prices hit their low and those who are following the crowd and buy as the market heads go down.
If the Sterling has been trading between $1 and $1.10 for a month and then begins to rise above $1.10, it could mean that greed has entered the market sentiment. That is positive. If you find that there is no good or solid enough reason for this uptrend, it is most likely that emotion, started it and it will fall back to the $1 to $1.10 that you were used to.
Fear works in the same way as greed and the motion can be as knee-jerk as you would imagine. Investors start to get concerned about losing money than they are about missing out on the opportunity.
In short, fear and greed, drive everyone to do what they do and they will buy over-priced securities or sell them for a loss or for less profit than they could have.
You must know how to spot when fear and greed take over, so you can use it to know when the market is about to take a turn.
What is Dumb Money?
We have mentioned dumb money a few times and now, we want to look into it and understand what the term means and how it fits into all this. When we talk about dumb money, we are referring directly to the major emotions that drive all market sentiment; fear and greed.
Dumb money refers to the instances where the traders take the most popular and obvious choice. It is when most of them are taking the hottest position. The thing about that is that the more people join, the more they become vulnerable.
Here’s how that breaks down in the forex market, where individual traders have to compete with banks to be successful in their choices. Forex is susceptible to market sentiment. Both the banks and the traders can see where the dumb money goes.
It is at that moment when the smart traders and banks open an opposite position and take profit from this.
You can use indicators that show the number of traders who have a short or long position on an asset. The market almost always goes in the opposite direction of the overly popular sentiment and cleans out the accounts of those who follow the crowd.
Here’s How You Trade Market Sentiment Effectively
First, you can start with volume. The volume metric can allow you to evaluate the markets’ feelings. This is very true when it comes to stocks and options as you can see when it is pointing to rising or falling interest.
Let’s say that a company’s share price continues on an upward trajectory but the volumes are dropping off. This could indicate that there is a weakening sentiment.
Pro Tip: It is harder to measure volumes in forex because people trade Over-The-Counter, rather than in a centralized market like stocks market. That makes trading volumes less reliable and harder to evaluate in forex.
There are a few indicators we need to look at before we conclude this forex sentiment topic.
- COT- Commitment of Traders
The COT is published by the Commodity Futures Trading Commission (CFTC), every week on Friday. It shows the net long and short positions of both the commercial and speculative traders. With it, you can outline the market by knowing how big traders like hedge funds, banks, and corporations are positioned in terms of options and futures.
You can know how committed they are to the current trends. If the COT shows major traders shifting to the bearish attitude, where it has so far been a bullish market, it could indicate a potential turn in the market.
You can do the same thing with forex markets, to get a handle on forex sentiment.
- VIX- The Volatility Index
The market likes to call it the fear index. It tracks prices and measures the volatility of options. With it, the higher the volatility implied, the higher the fear. With this in mind, the current could be indicating an oncoming snap. Low volatility shows that market sentiment is stable and the current trend will keep going.
- High/Low Sentiment Ratio
If you want to find out if the market is in a bullish mood or a bearish one, this indicator could be the answer. It involves the comparison of how many stocks are headed for their highest level in 52 weeks to the amount of headed for 52-week lows.
If it is headed toward the lows, it means that the bears are controlling the market and if it headed for the high, the bulls are in control.
- The Bullish Percentage Index
This index is a clear way to know how the bullish market is doing. The index shows buy signals, lists amount of stocks within the given index that have given the buy signal. Its purpose is to know if the market is over or undersold. About 70-80% of the stocks have buy signals for the market to be considered overbought and ready for a downtrend.
A reading below 20% or 30% implies that the market is oversold and could rise.
- Moving Averages
With the moving average, you will be able to identify when a market could break higher or lower. The percentage of stocks that are above average, it could mean that the market is ready to rise or drop.
With this, you can measure the put options and, in that way, know when the price will go down. That value divided by the number of call options, which expect a rise in price, you get the put/call ratio.
A ratio above 1, shows that investors' market sentiment is gravitating toward a slowing in the market or a fall.
The best thing to do it track market sentiment as much as possible.
There is a lot to learn when it comes to market sentiment. However, you must understand the way that fear and greed influence people. Forex sentiment can make all the difference between how much money you make or lose.
We have taught you all the essentials, including what dumb money means and we think you have what it to takes, to be good at forex trading, using the sentiment.
The only thing that could make this even better is if you could get the best forex broker in the world. That is easy when you have our forex broker reviews. They will point you in the right direction so you do not have to fumble around too much.