“Emotions are the key to understanding financial markets. However, it is difficult to make rational decisions based on them. Even if you think you read other people’s emotions or emotions, you may get lost in trying to understand how people are feeling. And market sentiment is the emotion of millions of traders around the world.”
The behavior of the masses works differently from the mechanisms that determine individual action. This discovery is quite old and is well described in a book by the French anthropologist Gustave Le Bon in 1895 “The Crowd: A Study of the Popular Mind.” , inability to reason, lack of judgment from critical spirits, exaggeration of sentiments, and so on…”
Every trader knows the importance of emotions. You can see it in market volatility; You can see that some stocks are overvalued compared to the company’s fundamentals, and others are undervalued.
Just as people at rock concerts, football matches, or political demonstrations move from individuals to crowds, traders around the world create entities that have emotions and moods. The state of mind of a crowd of traders is called market sentiment.
Market sentiment is one of the three enabling pillars for any trading strategy:
Reading Market News Sentiment
For Forex and especially cryptocurrency traders, fundamental analysis is much more difficult to implement than in the stock market. That is why traders of this market focus on technical analysis.
BULLS, BEARS AND “DUMB MONEY”
Understanding sentiment will let you know whether the crowd is optimistic (bull market), cautious or pessimistic (bear market) about currencies, stocks or cryptocurrencies. Identifying current trends can help you predict future overall market sentiment and will open up sentiment-based trading opportunities.
Market sentiment works for all types of markets, but is very hard to read. There are big players, such as institutional banks that can play against the prevailing sentiment, and seek so-called “stupid money.” the power to trigger a reversal.
FOLLOW OR COUNTER MARKET SENTIMENT
There are two possible strategies for using market sentiment. You can go with the flow and try to join the crowd or trade against sentiment. The first strategy will include tactics involving the Fibonacci retracement tool, which can help traders profit from local price corrections.
The second strategy is all about hunting for a reversal identifying support and resistance levels and considering the overall market sentiment to decide if a breakout is possible.
Safe-havens play an important role when market sentiment becomes extreme, or there is tremendous uncertainty. Assets such as gold, USD, CHF or JPY are considered excellent shelters if there is too much risk. When more volatile assets enter a bear market, traders (including the most prominent players) tend to seek these safe-havens, which automatically creates a bull market in ultrasafe assets.
THE TWO MOST DOMINANT EMOTIONS
Fear and greed are the most dominant emotions among traders. They are afraid of losing money, or wanting to earn more. Greed was overwhelming at the top of the market when the bubble was created.
More and more people are opening the same long positions on hot assets be it technology companies, fast-growing economic currencies or popular digital currencies. Just look at the most significant crypto boom.
On the other hand, fear takes over when the market bottoms out. traders panic about underestimating the true value of an asset. A savvy investor can see an opportunity to open a long position in this situation. However, trading against the trend always involves high risk.
How to identify fear or greed? When you see a trend accelerating the breakdown of a new resistance level with no underlying explanation – no important information to justify it – you might expect greed to be on the way. The same mechanism applies the other way around with fear. If during a downtrend the support level was broken for no apparent reason, fear may have taken over.
HOW TO RECOGNIZE “DUMB MONEY”
“Dumb money” is where traders take the most popular and most obvious moves. Everyone takes the hottest position, more and more people join in and put themselves in a very vulnerable position.
Let’s take a look at Forex, a market where individual traders compete with the biggest banks to make successful trades. Forex is vulnerable to market sentiment. The biggest institutional traders and the smartest individual traders see where the “stupid money” goes. Then when the timing is right, the most prominent player opens the opposite position and takes advantage.
You can find indicators that show the number of traders who have short or long positions on an instrument. It turns out that the market almost always suddenly moves on the contrary by quickly clearing the trading accounts of those “hanging out with the popular kids,” who follow the crowd.
Market sentiment is very easy to read if you look back. Everything seems visible. Even if you are new to trading, you can easily see greed taking over just as the bubble is about to burst. However, at the time of the bubble, almost no one pays attention to it, even the wisest and most experienced traders.
It’s hard to profit directly from fear or greed taking over. Even if you can read past and present sentiments correctly, you need to know what the collective trader mood will be like tomorrow. Without insider knowledge or the ability to influence prices with your trading volume, it’s impossible to do it over and over again.
WHAT IS THE BEST MARKET SENTIMENT STRATEGY?
Keep away from it. If you don’t use the most popular technical analysis tools and don’t trade reversals, you can avoid the riskiest moves. If you don’t want to play “dumb money” but avoid it, you can focus on developing an effective trading strategy. You don’t need to know where the “dumb money” is going. All you need to know is where the “stupid money” is usually and currently.
There is no good way to chase sentiment. It doesn’t matter if you want to trade with it or against it. Predicting future sentiment is a risky move, which is why avoiding market sentiment altogether has proven to work best for you. By doing so, you can develop a sustainable trading strategy with the right mix of technical and fundamental analysis.
Don’t chase sentiment. Invest not in the most popular assets, such as EURUSD, but more out of reach. It is best to find your own niche. Don’t be a cattle trader. Choose one of hundreds of available instruments and use the best UX technical analysis and tools to learn how to trade effectively and not be distracted.