Sentiment Trading Strategy

KEY TAKEAWAYS

• Market sentiment reflects a market movement, based on traders' potential actions.
• Market sentiment is a third player along with fundamental and technical analysis in assessing market movement direction.
• Sentiment indicators are not exact buy and sell signals on their own, Trader has to wait for the price to confirm the reversal before acting on it.

Market Sentiment Definition

A market sentiment is an overall attitude and feeling of the investors with regards to the present price and the forecasted price of a security, index or other market instruments. Market sentiment is also called investor sentiment. It can be a positive, neutral or a negative one.

Market sentiment is important for technical analysis, since it influences the technical indicators and it is used by traders to navigate. Market sentiment is also used by opposing traders who like to trade in the opposite direction to prevailing consensus.

Investors describe market sentiment as bearish or bullish. When it's bearish - stock prices are going down. When bullish - stock prices are going up.

In these situations often time traders emotions drive the stock market and it might result in overbought or oversold cases. You can see, market sentiment driving force is feelings and emotions.

• Bullish Sentiment - in a bull market, the prices are expected to move in an upward direction. In this case greed is the moving force of the market.
• Bearish Sentiment - In a bear market, the prices are expected to move in a downward direction. In this case fear of losing money is the force.

Sentiment Trading Strategy

In Forex trading we have fundamental and technical analysis to assess currency pairs movement direction, but there is a third player that has a significant role in play, which is market sentiment. Sentiment indicator is another tool that can have an input for traders to extreme conditions and possible price reversals, and can be used in conjunction with technical and fundamental analysis. Before you continue reading about Sentiment Trading Strategy, you can strengthen your knowledge of forex trading by reading an article about "What is Forex trading and how does it work".

Market sentiment is a way of analysing Forex, stock and other markets' tendency to construct better trading strategies. These indicators show the percentage, or raw data, of how many trades or traders have taken a particular position in a currency pair.

These indicators show the percentage of how many trades or traders have taken a particular position in a currency pair. When the percentage of trades or traders in one position reaches maximum level, trader can assume that the currency pair continues to rise, and eventually, 90 of the 100 traders are long, hence there are very few traders left to keep pushing the trend up. Indication is for a price reversal.

As we mentioned earlier market sentiment is mostly created by emotions, which results in overvalued or undervalued stocks etc.. So some traders hunt those stocks and bet against them. To measure those markets traders use these indicators, not only to bet against, but to uncover the short-term trend:

• CBOE Volatility Index (VIX) - If traders feel the need to protect against risk, it's a sign of increasing volatility adding moving averages and the trader would be able to determine if it's relatively high or low.
• High-Low Index - When the index is below 30 - stock prices are trading near their lows, hence bearish market sentiment. When the index is above 70, stock prices are trading toward their highs, hence bullish market sentiment.
• Bullish Percent Index (BPI) - Measures the number of stocks with bullish patterns based on point and figure charts. When the BPI gives a reading of 80% or higher, market sentiment is extremely optimistic, with stocks likely overbought. When it measures 20% or below, market sentiment is negative and indicates an oversold market.
• Moving Averages - When the 50-day SMA crosses above the 200-day SMA - golden cross - momentum has shifted to the upside, creating bullish sentiment. And when the 50-day SMA crosses below the 200-day SMA - death cross - it suggests lower prices, generating bearish sentiment.

There are different forms and sources of Forex sentiment indicators. By using sentiment indicators, trader can learn when the reversal is likely to come, due to an extreme sentiment reading, and can also confirm a current trend.

Sentiment indicators are not buy and sell signals on their own, but they allow one to look for the price to confirm what sentiment is indicating before acting on sentiment indicator readings. Surely as any other indicator it's not 100% accurate in reading where the market is going, keep that in mind.