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How to Trade Market Sentiment

Aria Thomas

Mar 24, 2022 16:11

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The mechanism that causes individual acts differs from the mechanism that generates bulk behavior. The finding is fairly ancient, and it is extensively detailed in a book called "The Crowd: A Study of the Popular Mind" written by French anthropologist Gustave Le Bon in 1895. The following are some characteristics of crowd psychology, according to the author: "impulsiveness, impatience, inability to reason, the lack of critical spirit judgment, sentiment exaggeration, and others."


Every trader understands the significance of emotions. Market volatility demonstrates this; some stocks are overpriced in respect to the company's fundamentals, while others are undervalued.


Traders all around the globe create an entity with feelings and moods, similar to how people at a music performance, sports game, or political rally transform from individuals to a crowd. Market mood refers to the collective mentality of traders.


One of the three potential cornerstones for every trading strategy is market sentiment:


  • Technical Evaluation

  • Fundamental Analysis / News Trading

  • Market Sentiment Analysis


Fundamental analysis is far more difficult to employ for Forex and cryptocurrency traders than it is for stock market traders. As a result, these market traders place a premium on technical analysis.

The bulls, the bears, and "dumb money"

Understanding sentiment will tell you if the market is enthusiastic (bull market), cautious (bear market), or gloomy (bear market) about a currency, stock, or cryptocurrency. Identifying the current trend will allow you to forecast future overall market sentiment and will open up sentiment-based trading opportunities.

Market sentiment is useful in all markets, although it is difficult to interpret. There are large entities, such as institutional banks, that may go against popular opinion and seek so-called "dumb money." Wait until the public is all in on a certain position – long or short – and then utilize your trading ability to cause a reversal.

Follow or oppose market sentiment

There are two approaches to taking advantage of market sentiment. You may either go with the flow and attempt to join the crowd, or you can trade against the emotion. The first approach involves using the Fibonacci retracement tool to assist traders benefit from local market adjustments.


The second technique is based on looking for reversals. Identifying support and resistance levels and considering general market sentiment to determine if a breakthrough is possible.


When market sentiment reaches extremes or there is a great deal of uncertainty, safe-haven assets play a vital role. In the event of excessive danger, assets such as gold, USD, CHF, or JPY are regarded as ideal safe havens. When more volatile assets experience a bear market, traders (including the most notable players) prefer to seek these safe havens, resulting in a bull market on ultrasafe assets.

The two most powerful feelings

Among traders, fear and greed are the most powerful emotions. They are either terrified of losing money or desire to make more money. Greed is overpowering during market peaks, which is when the bubble is formed. More and more individuals are taking the same long position in a hot asset, whether it is a software business, a currency of a rapidly rising nation, or a popular cryptocurrency. Take a look at the most notable crypto explosion.


Fear, on the other hand, takes hold when the market reaches its lowest. Traders are panicky, underestimating an asset's true worth. In these scenarios, a clever investor may spot an opportunity to establish a long position. Trading against the trend, on the other hand, is always risky.


How can I tell whether I'm afraid or greedy? When you witness a trend advancing and shattering new resistance levels with no fundamental rationale — no essential information to support it – you may anticipate greed to be at work. When it comes to dread, the same process is at work. If support levels are breached during a decline for no apparent cause, dread may have taken control.

How to Identify "Dumb Money"?

"Dumb money" refers to the most common and obvious movements made by traders. Everyone vies for the hottest position, and more and more individuals join, putting themselves in a vulnerable position.


Let's look at Forex, a market in which private traders compete with the world's top institutions to make profitable deals. Forex is just as vulnerable to market emotion. The largest institutional traders, as well as the most astute individual traders, can observe where the "stupid money" flows. Then, when the timing is appropriate, the most notable players open an opposing position and benefit.


Indicators that indicate the number of traders who have a short or long position on an instrument may be found. It turns out that the market nearly always abruptly reverses, quickly emptying the trading accounts of those who "hang out with the popular kids," that is, those who follow the crowd.

The bias of hindsight

If you look back in time, you can easily understand the market mood. Everything appears to be on display. Even if you are new to trading, you can readily detect greed taking control just before the bubble bursts. However, during the bubble, no one detects it, not even the most astute and seasoned traders.


Profiting directly from fear or greed taking control is tough. Even if you can accurately analyze past and current emotions, you must predict what the aggregate traders' attitude will be tomorrow. It's hard to do it repeatedly if you don't have insider information or the capacity to affect prices with your trading volume.

What is the most effective market sentiment strategy?

Stay clear from it. You can avoid the riskiest movements if you don't utilize the most popular technical analysis tools and don't trade reversals. If you don't want to play "dumb money," but still want to avoid it, you might concentrate on building an efficient trading technique. You do not need to know where the "dumb money" will end up. All you need to know is where the "dumb money" is typically and now located.


There is no good method to pursue emotion. It makes no difference whether you wish to trade with it or against it. Guessing future sentiment is a dangerous decision, which is why ignoring market sentiment entirely may be the best option for you. By doing so, you may be able to develop a long-term trading strategy that incorporates both technical and fundamental analysis.


Don't be swayed by emotion. Invest in assets that are less popular, such as EURUSD, rather than those that are more popular. It's best to carve out your own niche. Don't follow the herd. Choose from among the hundreds of instruments available on SimpleFX WebTrader and use the finest technical analysis. UX and tools to help you understand how to trade well while being calm.

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