What makes financial markets move? What causes all the commotion in Forex Market ? Who decides when prices need to go up and when they need to go down? Believe it or not the answer is a phenomenon known as market sentiment.
While there are many factors that impact the market, many believe the overarching sentiment in the market is the most important deciding factor. And indeed it has been and still is the subject of economic and financial enquiry. Countless economists and market analysts have been trying to figure out which factors can influence the prices in any given market.
But as it has become evident since long ago, even centuries ago, we know that market sentiment might just be the big guy pulling the strings of the forex market. So in this article we are going to take a peek behind the veil and see how this force works and how you can use it to your advantage in the forex market.
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A Look at Market Sentiment in Forex
So what is market sentiment in the forex market? As we said in the beginning, among all the forces that play a role in the outcome of any given financial market, the sentiment in that market plays the most important role.
It doesn’t matter whether it is the stock market, commodities, real estate, crypto market, or the foreign exchange market that we all know and love. The sentiment of the traders in that market will define the outcome.
This means the trajectory and direction of prices all depend on the overall mindset of the people present in that market. And of course when we say people we mean the traders or shareholders or investors, etc. – depending on the market. However the majority of those people feel that the market as a whole will define the outcome.
The same is also true on a smaller scale about assets or trading pairs in the forex market. This means trader sentiment can also make changes in them. So for instance if the majority of users feel positively about the EUR/USD pair, then it will most likely experience a spike. It is only natural, since a positive outlook toward that pair in the forex market would drive trading volume toward it and that would in turn cause it to move bullishly.
Knowing how to use market sentiment to your advantage is crucially important. Since as the most important force in the forex market, you ought to know how to manipulate it, because otherwise you will be the subject of its movements.
So now that you know the sheer strength of how traders in a market can make changes only through their sentiment in that market, let’s take a closer look at the different types of emotions that are involved in this regard.
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How Can You Detect Sentiment in Forex Market?
Before we look at the different types of emotions, we first need to talk about how you can detect emotion in the market. While it is true that sentiment is not directly measurable, there are telltale signs that you can use to see its footprint.
The most common sign that is used to track sentiment and its impact in the market is volume. While there are other signs and factors that need to be taken into account, trading volume is usually where you can see the impact of market sentiment.
This is because the most readily available and direct impact of how traders are feeling about an asset or market can be seen in where they drive their money toward. So if they feel positively about a certain asset, it is only natural to see capital being poured in that asset.
This is why most of the sentiment indicators, as we will see in the following sections, rely on trading volume as their metric in evaluating and measuring market sentiment.
Fear and Greed: The Most Important Emotions in the Forex Market
Feeling positively and negatively can also be defined in other terms as greed and fear respectively. These two emotions are the most important emotions that govern the trading processes in almost all financial markets, including the forex market.
- Fear: the emotion of fear among traders is what usually causes a bear market or a bearish trend in an asset or trading pair. So for instance if we want to discuss the trading pair EUR/USD, if the overwhelming emotion among traders is fear, then it can easily cause a stagnation in prices or push them down into bear territory.
- Greed: on the other hand, the feeling of greed is what usually causes bullish runs and pushes prices higher. Similarly, if traders, the majority of them of course, feel positively or have a feeling of greed about a trading pair such as EUR/USD then it can easily push prices higher.
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How to Use Technical Analysis in Forex Market
There are certain technical indicators that are specifically used to understand the impact of market sentiment and then use it to your advantage. The following is a list of the most important ones:
- COT or commitment of traders, which is used to show, as the name suggests, the level of commitment that traders have in any given market. Naturally, if the COT value is positive for a market then it could potentially mean the prices are going to move toward the positive area. On the other hand, a negative value for commitment could potentially signal an upcoming bearish move.
- VIX or volatility index, which is used to track the level of volatility in the market. Naturally, if VIX is indicating a high volatility status in the market then it means fear has overtaken the market. On the other hand, if there is lower volatility it could be an indication that the majority of traders are feeling positively about the market.
- Lastly, we have the bullish percentage index or BPI. In very simple terms, these indicators tell us whether the overwhelming sentiment for an asset is to buy or sell that asset. Naturally, if according to this indicator the majority of assets in a market are in the “sell” status then the market is oversold and a bullish turn is on its way, and vice versa.
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We the people make up every single financial market in the world. Without us there would be no forex market or stock market. So it is only fair that we would be the most important and powerful force behind any market. As a result it is the concept of market sentiment, which is the overarching feeling or emotion of traders that defines the outcome of any market, including the forex market.