Forex Market Sentiment Indicator

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Forex Market Sentiment Indicators

Probably the best way to avoid getting caught up in the emotions of a currency trade is by combining technical analysis with fundamental and sentiment indicators. The use of sentiment indicators can give traders insight into the potential for extreme conditions and price reversals. The broad view given by fundamental analysis, combined with trends predicted through technical analysis gives investors an edge when trading currency pairs.

Sentiment indicators are not all the same. They come in various types and from different sources, but they can be used together or tailored to your preferences on which you find easiest to interpret.  Sentiment indicators come in different forms and from many sources. One is not necessarily better than another, but they can be used to complement one another or specific strategies tailored for an individual's preferences of information interpretation may need to occur.

How Forex Market Sentiment Indicators Work? 

Sentiment indicators show the percentage, or raw data, of how many traders have taken a particular position in any given currency pair. For example, if 60 out of 100 are long and 40 short on that same currency pair then technically you could say sentiment is bullish for this trade at 60%. 

The majority of traders in a certain position can often lead to the sentiment indicators becoming very useful. When this happens with our aforementioned currency pair, 90 out of 100 are long (10 are short). There will soon be few left that would have been able to keep pushing prices up as they continued their upward trend - and it's not unheard-of for an extreme situation like this one to catch all by surprise!

Momentum indicators become more useful when a currency pair reaches an extreme level of trading. When 90 out of 100 traders are long on the same position, you can assume that there is not much left to drive up prices in this trend. The reliability and usefulness for momentum indicators increases as we approach extremes in volume or sentiment among price followers

Sentiment indicates that it is time to begin watching for a price reversal. When the prices start moving lower, sentiment traders enter short because they assume other longs will need to sell in order to avoid further losses as the price falls out of favor with investors.

A sentiment indicator is not a buy or sell signal. Wait for the price to confirm before acting on these signals. Currencies can stay at extreme levels for long periods of time, and it may take some time until they finally reverse course. Sentiment indicators can be a valuable tool in predicting the future of currency prices but it is important to keep in mind that they are never an exact buy or sell signal. Wait for price confirmation before taking action on sentiment signals because currencies may stay at extreme levels without reversing soon after, and as stocks have taught us time and again, patience pays off!

You know that a currency pair has reached an extreme when the buying reaches 75%. When you see this happen, be prepared for a reaction from sellers. If you're looking for a reversal in price when most traders are short, then there's another indicator that can help. Every time the previous pair flipped under 85% of all shorts, it was followed by an immediate change to bullish sentiment and resulted in an increase on average by about 3%.

If your target is finding a potential reversal with positive trading implications if things go as expected this time around too - check out what happened last 5 times one side had over 82% of traders who were long or short:

Advanced Forex Strategies