How’s Mr. Market feeling?
Every forex trader will always have an opinion about the market.
“It’s a bear market, everything is going to hell!”
“Things are looking bright. I’m pretty bullish on the markets right now.”
Each and every trader will have their own personal explanation as to why the market is moving a certain way.
When trading, traders express this view in whatever trade he takes.But sometimes, no matter how convinced a trader is that the markets will move in a particular direction, and no matter how pretty all the trend lines line up, the trader may still end up losing.
A forex trader must realize that the overall market is a combination of all the views, ideas, and opinions of all the participants in the market. That’s right… EVERYONE.
This combined feeling that market participants have is what we call market sentiment.The dominating emotion or idea is that what the majority of the market feels best explains the current direction of the market.
What is Market Sentiment? 🤔
Market sentiment is basically the collective mood swing of all traders. It’s like the financial world’s emotional temperature.
Whether you’re playing in forex, stocks, bonds, or crypto, this invisible force is constantly shaping price movements.
As a short-term trader, ignoring sentiment is like sailing without checking the weather. Technically possible, but unnecessarily risky!
The Emotional Price Rollercoaster 📈📉
Here’s the thing about sentiment. It ultimately shows up in price action.
When traders get excited about a currency, they buy it (creating demand). When they panic, they sell it (creating supply). Pretty simple, right?
The market’s emotional states come in two classic flavors:
- Bullish: When prices are climbing and optimism reigns supreme.
- Bearish: When prices are falling and pessimism takes over.
Sentiment vs. Fundamentals: The Dynamic Duo 🦸♂️🦸♀️
While closely related, sentiment and fundamental analysis are different beasts:
- Fundamentals: The economic, social, and political forces that should logically move prices.
- Sentiment: How traders feel about those fundamentals (which may or may not be rational!).
Think of fundamentals as the actual nutritional value of food, while sentiment is your sudden craving for ice cream at midnight.
One is logical. The other is emotional. Both influence your actions!
The Eternal Battle: Greed vs. Fear ⚔️
At its core, market sentiment boils down to two primal emotions:
- Greed: “Prices are going up! I need MORE!”
- Fear: “Everything’s crashing! Sell before it’s too late!”
These emotions create a fascinating market paradox:
- When everyone’s extremely bullish (greedy), the market often reverses downward.
- When everyone’s extremely bearish (fearful), the market often bounces upward.
This is why contrarian traders make their living doing the opposite of what everyone else is doing. When the crowd is stampeding in one direction, they’re quietly heading the other way.
Remember: The market loves to punish the majority. Just when everyone agrees on the direction, that’s precisely when it changes course!
How to Develop a Market Sentiment-Based Approach
As a forex trader, it is your job to gauge what the market is feeling. Are the indicators pointing towards bullish conditions?
Are traders bearish on the economy?
We can’t tell the market what we think it should do. But what we can do is react in response to what is happening in the markets.
Note that using the market sentiment approach doesn’t give a precise entry and exit for each trade. But don’t despair!
Having a sentiment-based approach can help you decide whether you should go with the flow or not.Of course, you can always combine market sentiment analysis with technical and fundamental analysis to come up with better trade ideas.
In stocks and options, traders can look at volume traded as an indicator of sentiment.
If a stock price has been rising, but volume is declining, it may signal that the market is overbought.
Or if a declining stock suddenly reversed on high volume, it means the market sentiment may have changed from bearish to bullish.
Unfortunately, since the forex market is traded over-the-counter, it doesn’t have a centralized market. This means that the volume of each currency traded cannot be easily measured.
GASP!
OH NOOOO!!!!
Without any tools to measure volume, how can a forex trader measure market sentiment?!
This is where the Commitment of Traders report comes in!