Market Sentiment Concept
Every trader, starting their trading activity in Forex, strives to increase their level of well-being, which should be facilitated by successful transactions with currency. In this regard, it is important to be able to navigate in such a concept as market sentiment. Understanding how the market works from the inside will certainly help a trader to choose the most effective automated Forex trading strategies. Conversely, the lack of information on this topic can lead to rash and chaotic decisions that carry the risk of loss.
How do you understand what market sentiment is in Forex? First of all, a trader should grasp the essence of this term in a generalized context, after which the knowledge gained can be considered in relation to automated Forex trading. In view of the fact that the definition of market sentiment applies to both the stock and financial markets in aggregate, in our today’s material we will consider the concept of market sentiment, first in the global, general economic sense, and then in relation to currency trading in Forex.
Thus, market sentiment is the opinion that investors form about a security or currency. The significance of such a factor as the market sentiment is extremely high, because the psychological sentiment of a large group of people has a significant impact on the development of various trends in the growth or decrease of prices for trading products. It is generally accepted that when prices abruptly go up, bulls become the main players in the market, and when the dynamics of growth is diminishing, bears dictate their market conditions. Most traders keep questioning themselves: how to practically use the concept of market sentiment to their advantage?
In order to thoroughly study the subject of market sentiment and learn how to apply this information to increase the profitability of automated trading in Forex, below we will turn to the topic of the sentiment of the participants in a particular market, since here the preconditions from which a certain market sentiment can play a key role. Having learned to understand both the psycho-emotional and the economic components of these processes, you will be able to more rationally and predictably plan the execution of transactions with currency in Forex.
How to interpret the sentiment of participants in different markets?
Experienced traders agree that the prevailing sentiment in a particular market, coming directly from investors, are far from always based on objective or average data. Since a single trader can follow those automated Forex trading strategies that suit them specifically, another trader has the right to choose completely opposite trading methods and algorithms. Hence, it shows that there is still no single foundation that sets the tone for all market trends.
In order for you to imagine the big picture more clearly, we will give the following example. Specialists in the technical analysis field and day traders rely on market sentiment because technical indicators are affected by market sentiment correspondingly. This means that the forecasts for profit due to short-term price changes and, in fact, the profit itself is largely dependent on dynamically changing market sentiment. In addition, there is such a trading strategy in Forex, when the investor may trade in the direction totally opposite to the market sentiment.
As we can see from this example, different sentiment of market participants form diametrically opposite trading trends, and it is not possible to predict for sure how a particular trader will organize his automated trading in Forex, because this already refers to the sphere of personal psychology of a person, and not only to objective economic realities. The mechanisms of earning money from different investors can be very diverse, therefore, depending on market sentiment, the following types are distinguished:
- trading on the upward price trend (bullish market sentiment);
- trading on a price decline trend (bearish market sentiment);
- trading on overvalued or undervalued assets.
If we talk about the sentiment of market participants in a general sense, then during a period when the stock market is controlled by bulls, the value of securities, including stocks, investment shares and bonds, increases. The opposite is the process of falling prices for stock assets when the bears rule the market. It is believed that market sentiment is inextricably linked with the concept of a fundamental, base price, which, in turn, is already an indicator of the efficiency and reliability of a particular business.
Another interesting trading strategy is making a profit from the sale of shares, the value of which was initially either overvalued or undervalued. As a rule, in order for transactions in securities to be truly profitable, investors of this kind prefer to build on indicators of market sentiment. Of course, it will also be useful for currency traders in Forex to learn about such methods of measuring and predicting market sentiment, in connection with which we turn to the concept of market indicators.
How to measure market sentiment?
To find and select the optimal moment when transactions would bring the maximum profit to the trader, most experienced investors resort to using special indicators of market sentiment. Beginners who are just planning to start developing and testing automated Forex trading strategies should also know what indicators are implied here. Among them, there are four main types, and these indicators influence market sentiment. Let’s take a closer look at them:
- fear index (or Roman numerals VIX);
- moving averages;
- bullish index (expressed as a percentage).
How to correctly interpret market sentiment in terms of the “high-low” parameter? This index allows you to compare assets that have reached an absolute price maximum in 52 weeks with those assets that have fallen in price to a minimum over the same period. Threshold indicators within this index are the numbers 30 and 70, that is, the marks of the minimum and maximum prices. At the lowest reading of 30 points, bearish sentiment prevails in the market, and at the highest, bullish.
Any Forex trader will need to know about the so-called fear index. This index is most relevant to the value of options, but basic knowledge of the VIX index will be useful even when testing automated Forex trading strategies. If this index rises, it signals the need for asset insurance. Accordingly, the fear index itself speaks of the volatility, instability of the market, its increasing volatility, therefore, in this situation, a trader needs to take urgent measures to protect capital or any other assets from risks.
Moving averages are another index for determining market sentiment. This indicator is obtained over a fairly long period of time, and its identification takes from 50 to 200 days. Thus, a sample of 50 and 200 days is used, where the short-term moving average crosses the long-term one, forming “the golden cross”. If at the same time the trading momentum tends to shift upward, then this indicates bullish market sentiment. The reverse trend forms “the death cross” and is an indicator of bearish sentiment.
Finally, the last in our list of market sentiment indices is the Bullish Percent Index, measured purely as a percentage. This index refers primarily to stocks and calculates their number on the basis of figure and dot charts. Neutral markets are considered to contain no more than 50% bullish, while so-called “bullish” markets with a BPI of 80% and above signal the result of over-buying of stocks. The BPI-based market sentiment forecast is interpreted as negative if the index is 20%, which means, assets are already oversold.
Market sentiment in the context of Forex trading
Having a basic knowledge of what market sentiment is and how to measure it using various indicators, a trader is already helping himself by having useful information about the internal structure of the market. It would be natural to assume that this information should be useful to a novice trader when looking for the best Forex trading strategy and when setting up a robot assistant to the required parameters of automated trading. Understanding the economic structure of the market allows you to timely anticipate risky transaction scenarios.
Of course, it is difficult to absolutely accurately identify market sentiment in order to reduce risks to zero, but this measure serves as a good analytical tool for reducing or preventing unprofitable transactions, that is, with a competent assessment of the current market situation, even a novice trader will be able to benefit from emerging trends and trade profitably in Forex. What factors should you always take into account to improve the effectiveness of your automated trading strategy?
First of all, summing up our review, we recall that it is necessary to take into account the micro- and macroeconomic environment, which has a colossal impact on market sentiment. Any crucial social and political events, as well as unforeseen incidents, entail a series of changes in the price range for assets. The ability to correctly read the market sentiment indices and not to lose sight of the psychological component of trading will allow a trader to improve his skills in conducting transactions in Forex.
In order to take advantage of the newly acquired knowledge about market sentiment without any significant harm to your deposit, a reasonable measure for a novice trader would be to pre-test automated Forex trading strategies using a bot – an expert advisor, in which you can set adequate exit values from a trade in advance and make a profit. In this scenario, the trading process will be much safer for the trader, and the study of market sentiment will become an interesting analytical experience, which will certainly come in handy when making large transactions that can bring tangible profits.