Understanding Market Sentiment

In this article we’ll explore the meaning of market sentiment and how you can use it in your trading. Market sentiment reflects the mood of investors, showing whether they are optimistic or pessimistic – bullish or bearish. Sentiment analysis measures the psychology of the crowd of market participants. Emotion often drives markets and market sentiment is not always synonymous with fundamental value. Herein lies the opportunity for traders and investors.

Volume

Volume shows how much of a given financial asset has traded in a period of time. It is an important indicator of the mood of investors. For example if a security makes a new high or low but does this with low volume, it suggests that price may not follow through. If it breaks an important level with high volume, it suggests that there is more conviction among traders and that price may continue in the same direction. Volume indicators include On Balance Volume (OBV), Chaikin Money Flow and the Klinger Oscillator. Volume points to rising or falling interest among investors. (See also: Using Volume to Make Better Trades).

Commitment of Traders Report

The COT report is a weekly publication that shows the holdings of various participants in the U.S. futures market. Published every Friday at 2:30 ET, it shows the net long and short positions of speculative and commercial traders. The report reveals how large players in the market such as hedge funds, banks and corporations are positioned in terms of futures and options. If the COT shows a shift in sentiment, this could precede a change in trend in the market. You can find the Commitment of Traders report online on the CFTC website, here.

The Volatility Index (VIX)

Also known as the ‘fear index’, the VIX tracks options prices and measures implied volatility. Implied volatility is the market’s forecast of a likely movement in a security’s price. The higher the implied volatility the higher the fear that the current trend is about to snap. While low implied volatility suggests sentiment is stable and the current trend will continue. A rising VIX means an increased need for insurance in the market. 

Moving Averages

Investors often use the 50-day simple moving average (SMA) and 200-day SMA when determining a market’s sentiment. When markets are trading above these moving averages it is deemed bullish and vica versa for below. When the 50-day SMA crosses above the 200-day SMA – referred to as a “golden cross,” it indicates that momentum has shifted to the upside, creating bullish sentiment. Conversely, when the 50-day SMA crosses below the 200-day SMA – referred to as a “death cross,” it suggests lower prices, generating bearish sentiment. (See also: Introduction to Moving Averages).

Forex Market Sentiment Indicators

DailyFX provides client sentiment data based on all live IG trades in the forex, commodity, cryptocurrency and indices markets and acts as a contrarian signal. Traders look to trade in the opposite direction whenever sentiment reaches an extreme. Client Sentiment is regarded as a contrarian indicator because the majority of retail traders try to fade the trend and pick tops and bottoms. In addition, when they are wrong about picking the tops and bottoms they will be forced out of their positions, driving the market further int the direction of the trend. 

 

Conclusion

Market sentiment is a useful secondary indicator that can increase your odds of success when combined with technical and fundamental analysis.