Trading the Market Sentiment
We all know that trading in the Forex market is not easy. Sometimes every technical indicator points to a certain direction but the market moves in the other direction. Other times the fundamental outlook of an economy is very bearish for the currency of that country, yet it keeps moving higher against other currencies. A good example of this is the uptrend in EUR/USD from mid 2012 until May this year. The economy of the Euro Zone as a whole was in stagnation with many countries still in recession, the political scene was unstable and the inflation was falling, which would be bearish for the Euro. Across the Atlantic the US economy was performing pretty well, but this pair kept marching higher to 1.40. Another more recent example, is the up move in EUR/USD in early October, from 1.25 to 1.29 in just a few days. On Friday the week before, the US unemployment rate declined from 6.1% to 5.9% and EUR/USD fell about 170 pips.
On Monday the following week the pair climbed higher which looked like a normal retrace after such a big fall. So what do you do on such occasions when the downtrend is so strong?
Obviously you sell during retraces and that´s what we did. The pair kept crawling higher and we kept selling, first at 1.2540 then at 1.2550 and finally at 1.2570. But this pair reversed the 1.7 cent loss on that day and reached 1.29 in a couple of weeks. So what happened, why was it moving up when all fundamental and technical indicators all pointed down? The answer is the Market Sentiment.
Market sentiment is very important and you should learn to read/feel it if you want to trade forex and all other financial markets. Sometimes it´s easy to read it because you just look at the main trend of a certain pair in the charts, like the uptrend in EUR/USD from 2012 to 2014. But it´s not always so easy, the same as in the second example and you might lose all the funds in your account.
But what is in fact the market sentiment? Market sentiment is the momentum of the market.
All traders, small or big, have an opinion when trading in the Forex market. Some might be bullish and some might be bearish. The market sentiment is all their opinions combined, even yours if you are trading.
Ways of reading the market sentiment
We often hear that the most important indicator is the trend. The trend shows the market sentiment. But trends sometimes can be tricky to trade. You might be a daily trader trading the 15 minute and one hour charts and the trend there might point to a direction, so you place a trade in the same direction. Hours later you see that the trend has changed and you are losing money. How did the trend change so fast? Well the trend, the bigger trend in the 4 hour or daily chart might have been in the opposite direction and the trend you were looking at was just a correction of the bigger trend, or a trend within a trend as they are called. So before placing an order based on a smaller timeframe chart you have to look at the bigger time frame charts. This way you can see how the market feels and which side it really is positioned on.
Price action Another way to understand the market sentiment is to concentrate at one pair at a time. This way you´ll get the feeling of this pair. There are successful traders that trade based only on their instinct of the price action. You have to observe how fast a certain pair moves in both directions.
If the up moves are faster than the down moves, it shows that the traders are willing to buy first and ask questions later. This means that the overall market sentiment is bullish. You can also watch how a pair reacts to economic news related with both currencies. For example, if we´ve had good economic news from the UK but the GBP/USD bounces based on the good economic data are getting smaller every time, it means that the market sentiment for this pair is turning bearish. It´s even more bearish if good economic news in the recent past hasn´t been able to form an uptrend. The COT Report When you trade stocks you can look at the volume that is being traded because the stock market is centralized on the stock exchange floors, but this doesn´t apply to Forex. The best volume indicator in the spot Forex market is the Commitment of Traders Report (COT), which is published on Fridays at 7:30 GMT by the CFTC. It shows the net short and long trades of commercial and non commercial/speculative traders in the Forex futures market. By using this report you can see how the big guys are positioning because that will affect the spot Forex market in the near future. As usual the best way to trade is to go with the trend so it´s obvious that you buy if there are more net longs and sell if there are more net shorts. But there are occasions that it´s best not to go with the trend. When the buy positions are in extreme levels, it best to sell or at least wait, because if everyone has bought there´s not many people left to buy and a currency cannot rise if no one is buying. Sooner or later they will close their buy positions so a reversal might be near. It´s better to use this indicator/report for medium to long term trading, because it is a weekly report. If you are a short term intraday trader you can use it to indicate the trend. International events The international events are important in setting the market mood. Some of them might happen on the other side of the globe and might seem like they´re not related to a certain currency, but in this global world we live in everything is connected and affects the markets, especially the financial markets. The nuclear plant disaster in Japan a few years ago had a big impact on all major currencies across the world. At first glance the Swiss Franc has no relation to what happens in Japan, but it is a safe haven currency so it surged higher amid fears of another global crisis. Another very recent example is the crisis in Russia a few weeks ago. EUR/USD doesn´t have any direct connection to Russia but the flow of cash from Russia into the Euro Zone helped this pair move about 300 pips higher.
In conclusion Market sentiment is a very important aspect of trading in the Forex market and all other financial markets. All these factors set the mood of the traders and decide what the market sentiment will be. It looks difficult but if you are serious about becoming a trader you have to make the effort and practice a lot, because getting to feel the market in your veins comes only with experience.