What is market sentiment & how to use it?

Traders are often searching for new indicators that help them to understand the market better and allow them to enhance their trading strategies. While the indicators that could be plotted over the chart remain the most popular, there are actually other tools that can benefit your trading strategy quite a lot. Today we are going to uncover one of such tools – market sentiment.

What is market sentiment?

The good news are that this indicator does not have any mathematical formulas behind it, hence understanding it is pretty easy. Also known as Bulls and Bears, market sentiment is a tool that is used to measure the psychology and the attitudes of the trading crowd.
Imagine EUR/USD is currently traded at 1.1500. As a matter of fact, there should be traders with long positions. However, there are also should be trading going short on this currency pair. The main question is, whether does the majority of the traders predict the market to go? And this is easily answered by the market sentiment. The indicator is usually shown as a pie chart that is split into two parts – traders that are short and traders that are long on a given instrument.

How to use market sentiment?

This tools has been mostly common in combination with different day trading strategies and technical analysis. Typically a trader that opens and closes his positions within a day is going against the general crowd. This is why it is wise to check market sentiment and understand where the market is predicted to go.
An important thing to take a note of is that most of the market sentiment tools are disregarding the trading volume. In other words, Trader A may be short on EUR/USD for 25 lots, while Trader B is long on EUR/USD for 1 lot. Nevertheless, both of them would contribute equally towards market sentiment.

Where to get sentiment data?

There is no centrally aggregated market sentiment for FX market, hence whatever you are able to find will demonstrate only a fractional part of the market participants. Typically some of the brokers provide their own sentiment based on the data gathered within their trading terminals. It contains quite a few instruments and large charts that are easy to read.
With a help of this tool you can easily preview the major currencies and see the beliefs of the crowd. However, it is strongly recommended to use market sentiment data from more than a single source. Ideally you should consider a the data that comes from some 3 or even 4 major brokers as it might differ quite a lot.
It is pretty hard to state a correct usage of the market sentiment as it is a secondary indicator. It is recommended to test it at first. While you are opening the traders using your regular strategy, simply take a note of the current position of the market sentiment. After you have completed some 20 or 30 trades, go into analysis and check how many winning trades came when you were following the majority of the traders and how many are achieved when betting against the common opinion. This way you will be able to see better the side of the crowd you should take.


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