With around 6 trillion dollars of daily transactions and thousands and thousands of traders participating, the forex market is a difficult place for making correct and sound speculations.
As such there are so many different glasses overlooking the forex market. These glasses each come with a different color and pattern that help you see one side of the market.
One specific looking glass that we want to discuss in this article is the concept of market sentiment.
What Is Market Sentiment in Forex?
Sentiment is considered to be an important indicator in any financial market and in the economy at large.
In the forex market, sentiment can be defined as the emotion, whether positive or negative, of a certain number of traders with regard to a currency pair or the entire foreign exchange market as a whole.
In other words, market sentiment is the overall mindset of traders in the market. It makes for a big difference how traders are feeling about certain pairs. It can easily lead to bearish or bullish trends.
Naturally, a positive sentiment, including feelings such as optimism, excitement, thrill, and hope can result in bullish trends in the market. And vice versa, feelings such as pessimism, fear, panic, and anxiety would lead to bearish patterns.
Through detecting sentiments, we can see whether a trend is still on the rise or has reached a peak and is near its end.
There are different types of indicators in analyzing the market with the help of sentiment. Indicators such as VIX, the COT report, the ratios of put and call, the Ted spread, and many others which will be discussed shortly in this article.
How to Trade in Forex with Market Sentiment?
Along with other tools and techniques that are used in market analysis, sentiment tools and indicators can further help traders understand the market deeper. And such tools are essential for any trader, since market sentiment is powerful enough to make changes in the price movement even against other fundamental factors.
The basic and fundamental factors involved in market sentiment are two basic emotions of fear and greed. These two basic sentiments encourage traders to either make a move or abstain from taking a certain position.
Another way you can look at market sentiment with regard to market analysis is the volume of trades carried out. However, trading volume alone is not a definite indicator of the sentiment of traders.
However, trade volume in addition to the movement of prices can be taken as a deciding factor. Of course the increase or decrease in the traded volume should be in the same direction as the increase or decrease in prices.
For instance, if increasing trade volumes are accompanied with price increases, then it can be said that the overall sentiment and ergo market trend are bullish.
Now, let’s take a look at market sentiment indicators and what they mean for you as a forex trader.
Market Sentiment Indicators and Their Functions
Although market sentiments are divided into two major types of bullish and bearish, there are, however, various indicators that are used in the analysis of the market sentiment. Let’s take a look at the most important indicators.
VIX or the volatility index is considered to be one of the most popular indicators for market sentiment. As such, VIX can be used as a technique or tool to evaluate the amount of risk for traders who are more cautious and want to steer clear of market risk. Or, on the other hand, a method for finding out the best moments of volatility that can be used for maximum profits for traders using scalping.
The COT Report
The COT or the commitments of traders is a report that is released on a weekly basis. As such, it can be used for longer term market analysis and investigation of traders’ feelings and sentiments in the market. Therefore, we can use the overall COT report figures to find out the net long or net short positions.
Put and call options can be defined as special instruments that allow traders to make speculations on the future price of assets. The way we can obtain the put call ratio is to divide the totality of the volumes for put options by the totality of the volumes for the call options. Naturally, we can see what is the general sentiment or feeling of traders in the market and with regard to a specific asset or pair.
The high low index is an indicator that compares the price or value of an asset or trading pair at their 52-week highest with the price of value of an asset or trading pair at their 52-week lowest. This will provide us with a ratio that provides information about the prevailing market forces and market trends.
Developing a FX Trading Approach Based on Market Sentiment
So among all the other factors in the market, it is up to you as the trader to figure out the general sentiment in the market. This is so you can see whether the signs point to a bullish or bearish trend.
Remember, your own personal and subjective sentiments are of little importance to the big picture of the forex market. So instead of focusing on that, you need to focus on the overall market sentiment in order to take the proper steps.
But you also need to keep in mind that infusing your trading approach with market sentiment and related indicators will not give you a precise path forward to calculate entry and exit points. Rather, it will provide you with a general understanding or feel of the market.
The prevailing recommendation is to infuse market sentiment analysis with other forms of analysis. So that you will end up with a combination of methods for analysis, that includes fundamental analysis, technical analysis, and of course market sentiment analysis.
Market sentiment is one of the most important factors in the analysis of any financial market. It can tell you how traders in that specific financial market are feeling about the assets. As such, market sentiment can provide valuable information with regard to the forex market. It can tell you whether forex traders have a positive or negative outlook toward the market as a whole and also toward specific trading pairs.
There are many different indicators and indices that can help with determining the market sentiment. The most powerful and prevalent index is the traded volume for an asset in a certain period of time. However, because the foreign exchange market is by and large an over the counter market and there is no centralization, it might be a bit hard to come by such information.
Nevertheless, there are other indicators and indices that help you determine the overall market sentiment in the forex market to facilitate decision making as to when you should get on a trend and when to get off one.