Sentiment Analysis

Sentiment Analysis is a method of analyzing the market pricing behaviour of a certain asset class.

What is Sentiment? Sentiment can be best characterized as being the Mood of the market. This Mood can last seconds, minutes, hours, days and even weeks but is often thought of as shorter in duration than something like the fundamental trend that can be determined using Fundamental Analysis.

In this Wiki we will explore what sentiment is and the various forms and behaviours that sentiment can manifest itself in Forex and other financial markets.

One note to keep in mind is that this Wiki does refer quite a bit to how sentiment applies to Forex trading. However, sentiment trading is not just for Forex trading and it can be applied to other financial markets with great efficacy as well.

The contents of this Wiki will be best understood if you also study our Wikis on Fundamental Analysis, Economic data releases and Central banks. The information in those other extensive Wikis will really help to solidify this Wiki on Sentiment Analysis.

This Wiki is a part of our Essential Forex Trading Guide. Be sure to check that out HERE.

Market Sentiment

Introduction to Sentiment Trading

In this Wiki, we will introduce the concepts of Market Sentiment and Sentiment Analysis in the Forex Market. This build is the foundational information for the Sentiment Analysis Wiki and will set the foundation for all other Sentiment Analysis and applying Sentiment to the Forex market successfully.

In the Introduction to Sentiment Trading Wiki we will explore topics such as:

• Sentiment in Forex Trading
• Sentiment Golden Rule
• Sentiment Trading Example
• Fundamentals versus Sentiment
• Perfect Sentiment Trades
• Counter-Sentiment Trading Opportunities
• Challenges with Sentiment Trading

You can access the main Wiki on Introduction to Sentiment Trading Wiki HERE.

Risk On and Risk Off

Risk On and Risk Off is a market sentiment that happens a lot of the time across all financial markets including Forex. In the following Wiki, we will explore:

• Risk On
• Risk Off
• Sideways Market

You can access the main Wiki on Risk On and Risk Off Wiki HERE.

Safe Haven Flows

A Safe Haven is a type of investment that is expected to retain or increase in value during times of market turbulence or risk off trading. Investors and traders look to move money into Safe Haven products in order to limit their exposure to losses in the event of market downturns. However, what assets are actually deemed as Safe Havens can vary depending on the specific nature of the down market and how fast prices are moving.

In this Wiki, we will explore:

• What a Safe Haven is
• Why Safe Havens Exist
• The US Dollar
• The Swiss Franc
• The Japanese Yen

The main Wiki for Safe Haven Flows can be found HERE.

Corporate Demand

Corporate demand comes from large multinational companies that need to buy or sell currency for a variety of different reasons. Generally speaking, there are two main types of corporate demand that we need to be aware of in the Forex market:

1. Foreign payroll corporate demand
2. Foreign company purchases corporate demand

Foreign payroll corporate demand happens when a large multinational company from one country needs to pay its staff in a different country in the local currency. For example, a large U.S.-based corporation may need to pay its staff in Europe. In this case, it’s going to need to buy Euros in order to pay its European employees. To get Euros it will need to sell their U.S. dollars and buy Euros which is effectively done by buying the EURUSD currency pair. If the order is large enough then the company will likely move the price of EURUSD for a short period of time.

Companies perform all sorts of currency transactions on a daily basis around the world but this usually only impacts the markets when there is not much else going on to drive prices. If liquidity is low at the time of these transactions the order can suddenly move the price of a particular currency.

It is very hard to determine when foreign payroll corporate demand is hitting the market because it’s not something that is published anywhere. One thing to keep in mind is that the Asian session is driven mainly by corporate demand if there is no news happening in that session. This is because Japan and China are huge exporters to many different countries and those many thousands of large companies need to exchange their local currency to do business in other countries on a daily basis. So if you are trading in the Asian session and you suddenly see a spike in price with no reason behind it then this could potentially be foreign payroll corporate demand.

foreign payroll corporate demand is difficult to trade because you will likely be Speculating that it is taking place. However, it is worth understanding that huge volumes of currency exchange hands on a daily basis for this very reason. Generally, with corporate demand, it’s very hard to determine how long the moves will last.

The other kind of corporate demand happens when a large company decides to buy another large company that is located in a different country. This can have a more lasting impact sometimes setting the trend for an entire trading session. This is also something that you can speculate on because the news will be all over information outlets about the purchase and the exact details of the purchase or takeover date. So you will know to be on the lookout for a particular currency to move in a particular direction on a particular date.

An example could be when a U.S. company such as Apple buys a UK-based company. To do this they will have to sell USD and buy Great British pounds in order to complete the transaction. These transactions can be in the multi-billions. In this example, traders will try to anticipate that the required purchase amount of money will move the currencies involved. This can create an immediate wave of speculative buyers in GBPUSD trying to get in before the transaction actually takes place. We can choose to speculate as well or we can use the wave to alert us that the real transaction is happening soon and then we can look to get in the trade on a pullback and let the actual transaction take place to push our trade into profit.

Forex Option Expiry’s

Option Contract Expiry’s In Forex

Every trading day we have many different types of options contracts expiring at many different times against many different currency pairs. But how do they move the price of the currencies? In simple terms, the option price can act like a magnet at times.

The contracts that we are referring to are “plain vanilla” options only. There are indeed many variations of how options are structured but for the sake of simplicity, we will stick to plain vanilla options because they are the most widely used and tracked by the Forex market.

A plain vanilla options contract will be ‘’“live”’’ and in play until expiry time which is set at 10:00 am New York time (15:00 GMT) each weekday. We don’t actually see the details of whether it’s a ‘’“put”’’ or ‘’“call”’’ option unless you are dealing in the Interbank market. What we are looking out for is the price action leading up to the 10:00 am expiry time.

If there is an expiry of a big option of, say 500 million or larger, then this will bring the markets attention to the price of the option. If the expiry price is close to where the market is currently trading, say 30 to 50 pips, then the price may be drawn to that option expiry level.

There are a few things that may happen when there is a large option expiry leading into 10:00 am EST:

1. The price may head towards the price level. This could be because the buyer of the option contracts wants to cash in on their bet. The only way they can do that is if they push price to the price level. If it is a big enough payoff then it makes sense to use some more money and push price to the level.
2. Price may reject strongly off the price level. This could be because the seller of the option contract does not want to payout the money so they defend the price level by pushing price away from that level.
3. When price gets to the level it may not move too far beyond it as the buyers and sellers fight it out.

Once 10:00 am comes to pass the options are no longer in play. This means that the battle between the winning and losing party is over and price is free to move without any intervention from either of those parties.

The impact of an option expiry will largely depend on how big it is. However, if price is nowhere near the expiry level then the prevailing market sentiment will likely be the main driver of price action.

You can see these expiry levels posted in the news feed at Forex Live. Once you note where the large levels are you can mark them on your chart and spend a little bit of time watching how price reacts to help you learn how you might possibly take advantage of these events.

ForexLive.com/Orders

Value Traders

Value trading happens when value traders enter the market looking to position themselves in line with the long-term fundamental trend. They look to do so when the short-term sentiment has moved the price in the opposite direction of the fundamental trend. There will be traders watching this to try and use it as an opportunity to get back into the market at better prices because the sentiment has taken the price to an attractive point to get back in a trade in the direction of the big picture fundamentals.

Value traders can be classed as some of the largest hedge funds, banks, and investment houses in the world. Many funds are so large that they must become value traders because they need to have a longer-term outlook given they have financial assets that are too large to be efficient with shorter-term trading

These traders get in with the expectation of the fundamental trend resuming at some point. It could be that they are simply adding to an existing position at a more attractive price. This type of trading activity effectively ends any type of short-term sentiment that may have been in control up to that point because the volume tends to be quite large.

The general rule is the further the short-term sentiment has taken the price away from the fundamental direction, the more likely it is that value traders will look to get back into the market and hunt for a good bargain. Value traders will only be on the hunt if the price has moved significantly beyond the average daily range of the pair and over more than a single session.

This type of sentiment is not easy to identify but there are times that you can see the price has really overshot against the overall fundamental trend because of some short-term sentiment that the market has over focussed on. It’s at these times when the price has moved excessively that you can bet value traders are lurking in the shadows.

Many of the largest funds in the world use value trading to one degree or another in their investment mandate so you know that they do definitely have the power to move the market if enough of these traders decide that something has value at current prices.

High Frequency Traders

These traders are essentially automated algorithms that are designed to identify an opportunity in the markets and take advantage of it instantly and immediately. An example of these algos in play is when there is a large sudden and unexpected move in the price for no clear reason.

This happens fairly regularly and is often called a “fat finger” because it means that some trader at a bank or large fund has literally pressed the wrong button or accidentally entered the wrong trade size that was too big which instantly moves the price heavily.

When a trader fat fingers the market the high-frequency traders (HFT) are ready and as soon as they see that the price has moved a significant distance in a very short period of time for no apparent fundamental reason they will almost instantly trade it back to where the price was originally for a nice profit.

These HFT algos literally scan the market on a tick-by-tick basis using very powerful computers scanning for certain parameters in the logic of the algo to be met. The advantage that they have is that their orders are being executed within milliseconds which means that they get their orders filled long before any manual trader could possibly hope to execute a trade.

To visualize this we can use an example of the GBPUSD. The chart below is a 1-minute chart and you can see a rather large topping tail inside the red rectangle. This was a lightning fast move higher of 100 pips that was completely and almost instantly reversed by high frequency trading on both the buy side and sell side.

The situation with this trade was that Great Britain was in the run-up to a referendum vote on whether or not to stay part of the European Union. This was causing lots of volatility and created an expanding average daily range due to the uncertainty of the outcome of the future vote.

What happened was a major financial news network reported that the latest surveyed polls showed a larger than expected percentage for the stay camp which was being viewed as a positive thing for the currency. This is why the GBPUSD ran up hard initially. However, this report was published in error and was mistakenly written backwards. It should have shown a larger than expected percentage for the leave camp and the correction was made and published within 20 seconds of the first erroneous post. This is why the move was instantly paired back to where it was before the news ever hit the news feeds.

This was not a fat finger trade and it was definitely not caused by manual trading because it happened too fast for a human to respond to the news. However, this example highlights just how many algos there actually are scraping news feeds for keywords to drive the logic in their trading decisions. It also highlights how illiquid a major traded pair like the GBPUSD pair can become in times of uncertainty and volatility.

This brings us to a very interesting general rule of price action:

The further the price moves in a specific direction, and the shorter the time it takes to make this move, the greater the chance of the price retracing from that move back in the direction of the start point for the move. This is as long as there is not an economic data set that was just released because that would be a real move based on fundamentals and sentiment.

The driver behind this concept is the high-frequency traders trying to jump in and take advantage of irrational price moves instantly. Obviously, if there is a very good reason for the move such as a central bank unexpectedly announcing a major adjustment to their interest rate then the high-frequency traders will take losses as the rest of the market builds momentum in the new direction.

This concept of HFT is definitely something to keep an eye on and when you see a sharp move followed by an equally sharp retracement then this is most likely what is happening. Sometimes there is a tradeable opportunity that takes place if you can see that a lot of traders got trapped on the wrong side of the market and other times it’s more just to understand what is currently taking place in the markets. Very often the news feeds will find out that there was indeed a trader that made a mistake at a certain bank on the size of an order which makes it more interesting for us to learn that someone is probably out of a job today.

Range Bound Trading

As we know by now the market is driven by sentiment. Sentiment is a form of short-term fundamentals that is derived from news, economic data, and other events that occur throughout the trading session.

However, there are times when there is nothing on the Economic calendar that has the potential to move the market and maybe nothing much has happened in general in the previous sessions. What will occur in this case is something that is called range bound trading.

Range bound trading is where the price chops up and down with no real direction or purpose. This is often the kind of sentiment that catches untrained traders off guard and chops them and their account up because they expect prices to move but there is no real reason for the price to move and so it doesn’t move much.

Traders who only focus on Technical Analysis with no regard as to what the prevailing sentiment might be are particularly susceptible to this type of market environment because their expectation of price action does not fit with the reality of the day. Most professional traders that identify this type of market sentiment will either stay out of the market or completely adjust the way they are trading to suit range bound price action.

Most professional traders prefer price to be trending or moving with a higher level of predictability but there are many types of strategies that can be employed to take advantage of range bound trading. Profits tend to be smaller and the risks tend to be larger but if you have a strategy that can still pull a profit in this environment then that is great. A common trading strategy in range bound markets is playing technical bounces of major support and resistance.

The one thing to keep in mind is that eventually all ranges breakout and that is the point that range bound strategies tend to take very large hits that can sometimes outway the initial profits previously made. However, if you are good at identifying sentiment then you would already know that the market environment is changing before you take a big hit playing a range that is about to breakout. Recognizing what the prevailing sentiment is will actually improve your overall results exponentially over time.

Central Bank Member Stance

You might recall that Central banks are typically made up of committees that all vote together on matters pertaining to monetary policy. Each of these individuals that make up the committee will have their own personal opinion on the best way to run monetary policy. Some of them will believe that higher interest rates are better while others will feel that lower interest rates are best.

Higher interest rate advocates are called hawks and lower interest rate advocates are called doves.

A hawk is a policymaker or advisor who is predominantly concerned with interest rates as they relate to fiscal policy. A hawk generally favours relatively high interest rates in order to keep inflation in line with the central bank's mandate. In other words, they are more concerned that economic growth will get too high than they are with recessionary pressures.

A dove is a policy advisor who promotes monetary policies that involve the maintenance of low interest rates as a means to encourage growth within the economy because this tends to increase demand for consumer spending and borrowing. They believe that low inflation will have a worsening effect on the economy.

The market would expect a hawk to talk about things such as raising interest rates. At the same time, the market would also expect doves to talk about things relating to a lower interest rate environment. However, sometimes a hawk will talk about wanting lower rates or a dove will talk about wanting higher rates. When these voting members of the central bank talk in a way that goes against their traditional stance this can really have a large impact on the markets.

Think about this for a moment, if the member is changing their entire view of the economy then something significant must be occurring within the economy for them to think about switching camps. We only know what the central bank member has stated to the public but you can bet that if they are changing their stance, even temporarily, then something big is happening at the central bank that we have not been made aware of yet.

These can be fantastic trade opportunities but the key to taking advantage of them is doing your research and being aware of who each member is and what their traditional stance is. You can typically find a list of hawks and doves in your news feed or squawk service. You can also find central bank member stances by doing a simple google search.

It’s important to keep your focus on the main 8 Central banks because it is very rare that other central bank members move the markets with comments in the same way that the major Central banks do. However, if you are the kind of trader that wishes to become a specialist in the smaller Central banks you can do that as well because the process for monitoring smaller Central banks is the same as for larger central banks. Just keep in mind that you are typically trading in lower liquidity currencies and understand the potential danger that this may have on your trading business.

Central Bank Policy Divergence

Another common thing that drives price and is also related to the overall fundamental picture in Forex and other types of financial trading is something called Central Bank Policy Divergence. What this means is that traders will look at a currency pair and if there has been a recent pullback against the fundamental trend then the markets will likely start trading the pair in line with the stance of the Central banks.

For example, if the European Central Bank (ECB) is in the middle of a Quantitative Easing (QE) program while the Federal Reserve is in the middle of a rate hiking program then this means that the two Central banks are basically going in the opposite direction in terms of their monetary policies. This will cause traders to sell the weaker currency and buy the stronger currency over the long term as long as this inverse relationship stays intact.

In this case, the Euro is weak because QE is basically the printing of unlimited money which devalues the currency. On the other hand, the United States is hiking interest rates which is the most fundamentally bullish thing for a currency in the Forex market. In our example, traders would be looking to short the EURUSD currency pair because of this central bank policy divergence. When you short the EURUSD you are essentially selling the weaker Euro and buying the stronger USD.

Taking trades such as this will work best on pairs with clear central bank policy divergence. This means that both banks are literally going in the opposite direction with their monetary policy actions. For example, one bank is cutting its interest rate while the other is hiking its interest rate. This is a perfect long-term fundamental trading opportunity for Forex traders.

The market may focus on central bank policy divergence at any time which is in contrast to value traders who will wait for really attractive prices before committing to or adding to a trade.

bank policy divergence generally lasts the entire trading session so it can be a useful sentiment to trade on any pullbacks that might occur.

There are examples when there is a clear policy divergence but the market expectation is such that it believes and has the expectation for the divergence to come to an end. For example, if the Federal Reserve is in a QE program but is now looking to take action to taper and end the QE program soon while the BOE is in a rate hiking cycle but is talking about putting this on hold for the foreseeable future.

This is an example where we have a clear policy divergence because one central bank is printing money which has the effect of weakening the currency while the other is raising interest rates which we know is really bullish for the currency. However, the market expectation is that each central bank is going to stop what they are doing soon and switch to some other form of monetary policy. This is a time when the central bank divergence is unwinding and not something that we want to continue to trade in line with unless we are trading it the way of the new Expected policies. Trading in line with the new expected policies can actually get you into a new trend very early which can provide many nice profitable trading opportunities for a long time to come.

This is also a good time to remind you that the expectation of the market is often more important than what is actually happening right here and now because the market is a discounting mechanism and wants to price in new information as quickly as possible.

Forward Guidance

Forward guidance basically means that the Central banks will tell the market as clearly as possible what its intentions are and what the time frame is for carrying out their mandate.

Forward guidance is verbal assurances from a country’s central bank to the public about its intended monetary policies. Forward guidance attempts to influence the financial decisions of households, businesses and investors by letting them know what to expect from interest rates to the extent that the central bank can influence those rates.

The central bank’s clear messages to the public are one tool for preventing surprises that might disrupt the markets and cause significant fluctuations in asset prices. Forward guidance is a key tool of the Federal Reserve in the United States. Other Central banks, such as the Bank of England, the European Central Bank, and the Bank of Japan use it as well while other Central banks choose not to offer it.

In the United States, the Federal Reserve’s Federal Open Market Committee (FOMC) has used Forward guidance as one of its major tools since the Great Recession. Through the use of Forward guidance, the FOMC intends to help interest rates remain low to improve credit availability and stimulate the economy.

Forward guidance consists of telling the public not only what the central bank intends to do, but what conditions will cause it to stay with its current mandates and what conditions will cause it to change its approach. This is a very important distinction to make with Forward guidance.

Forward Guidance Example

For example, the FOMC in late 2013 and early 2014 said that it would continue to keep the federal funds rate at the lower bound at least until the unemployment rate fell to 6.5% and inflation increased to 2% annually. It also said that reaching these conditions would not automatically lead to an adjustment in Federal Reserve policy. That is very specific information for the market to focus on and price the US dollar when those changes start to take place. Janet Yellen, sworn in as Fed Chair in 2014, is a strong proponent of Forward guidance.

With some sense of where the economy might be headed, individuals, businesses and investors can have greater confidence in their spending and investing decisions and financial markets may be more likely to function smoothly.

For example, if the FOMC indicates that it expects to raise the federal funds rate in six months, this means that potential homebuyers might want to get mortgages ahead of a potential increase in mortgage rates.

With this in mind, the first place your research and analysis should take you is the Central banks themselves. They release statements and forecasts regularly via their websites. Traders work hard to decipher these releases for clues about the future monetary policy. Very often traders will focus heavily on certain words within the central bank release because these words or phrases are the things that are changed or replaced when policy is about to change.

For example, around the end of 2014 the Federal Reserve in its statement on monetary policy stated that it will likely wait for a “considerable time” before raising its interest rate. Traders in the market knew that when the economic conditions improved the Fed will at some point be forced to remove the “considerable time” wording from its statement. Sure enough, a few months later they removed that phrase and replaced it with saying they would be “patient” with beginning to normalize monetary policy. Normalizing monetary policy simply means that they are intending to bring interest rates back to a more historical percentage rate rather than being low forever.

This change may seem minor but to the markets, this was a subtle step towards rate hikes delivered in a way so as to not cause chaos in the markets. This is a very good example of how a central bank provides Forward guidance and communication to the markets in tiny steps any changes that it wants to make. This ensures that the markets are often expecting the moves before they actually happen and will significantly limit violent reactions in the markets.

By switching to the word “patient” the Fed allowed itself more flexibility of when the rate rise would actually come and communicated to the markets that a hike would only happen if the data supported such a move. A “considerable time” does not really allow for a hike within the next three months whereas if they are being patient they can hike at pretty much any point after the initial month following the change.

This was a typical example of the types of word games played by Central banks around the world. Very often you will not need to worry about which words are important or what they mean because as we will see in a moment it is the job of analysts to conduct this interpretation for us so that as traders we have a clear picture of what the central bank is thinking so that we can devise a strategy to trade profitably.

Buy the Rumour Sell the Fact

Buy the rumour sell the fact is one of the more common types of sentiment that you may have heard about before because it is so prevalent in that markets that it has even become a cliché in the trading world.

What does this mean and why should you be concerned about it while you trade the Forex or other financial markets? Buy the rumour sell the fact occurs when the market expects a certain outcome and trades in line with that expectation going into a particular risk event. As the event is released or takes place the market abandons the trade and reverses the price action as it starts taking profits from the nice profitable run-up into the event.

Buy the rumour sell the fact is the driving force behind the concepts of something called trading into risk events.

For example, imagine that the market is anticipating that the Bank of Canada (BOC) will increase its main interest rate. Speculation started about 2 weeks before the rate statement and there have been various leeks to the press about the fact that the hike is going to happen. What will happen in this type of scenario is that the price of the Canadian dollar will rally as speculators attempt to get in well ahead of the actual event.

As the rate statement approaches the market has done a good job of fully pricing in the rate hike into the Canadian dollar. When the event happens and the BOC does indeed hike interest rates as expected what you will likely see is instead of the market buying up Canadian dollars the market begins selling them off after an initial spike higher. New traders get squeezed out of their positions that they entered just after the announcement and end up losing money as the price goes opposite to what they thought it should or expected it to be doing based on everything they have learned about FX and how important increasing interest rates are to the FX market.

So what happened in this example? The market had been so confident that the rate hike would happen that they started positioning themselves before the interest rate hike had been confirmed by the BOC. When the time came the smart money market participants were already in profit and decided to book those profits rather than risk getting into a new position. They booked their profits buy selling their long positions causing the price to move lower.

When done in enough volume, this profit taking can actually move the price of a currency significantly and is often seen at the end of large moves or at key support and resistance points in the session. As the rest of the market catches on to the fact that this has become a buy the rumour sell the fact type move they now start selling the Canadian dollar to try and take advantage of this fact which of course pushes the currency even lower.

This can be a very frustrating thing to newer traders trying to understand fundamentals and sentiment. This is the kind of event that causes retail traders to think that fundamentals and sentiment don’t work and it’s hard to blame these people. But the fact is there are all kinds of reasons that the market will do what it does and this is just another one of those things.

This brings us back to the golden rule of sentiment: The more something is known to the market the less of an impact it will have when it actually happens. This is precisely why Central banks try so hard to play with their language and statements in order to let the markets know about any upcoming policy changes as clearly as possible so that it’s never a surprise. This helps to keep prices stable which is one of the Central banks most important mandates.

In the example we just looked at the sentiment would dissipate and the market would switch back to the central bank divergence or the overall fundamental picture. But as you can see, short-term sentiment is vital to be aware of if you are to make a profit. If you are not properly tuned in and understanding exactly what the market is thinking at that moment then you will be very likely to get caught out and lose pips at times when you should be making pips.

Leading Asset Classes

There are times when there will be nothing driving the FX markets, no news, no central bank action, and no external demands in the market. During these times the markets will either be range bound, as we looked at earlier, or be led by other asset classes.

Asset classes that can lead the Forex markets include things like commodities, equities, and bonds. It is a good idea to refer back to the Fundamental Analysis Wiki for more information about how different asset classes impact the Forex market. Generally, if it is clear that the market is simply being led by another asset class then there will likely be very little in the way of trading opportunities. While you can try and take advantage of the moves, you will need to adjust your strategy to focus closely on whatever asset class is moving hard, and most importantly, the reason that the asset class is moving so hard in the first place.

In times when commodities are the leading asset class they will tend to move currencies such as the CAD, AUD, and NZD. The idea is to look for a country that has a dependence on either importing or exporting the commodity that is experiencing a lot of price movement or is heavy in the news feeds.

Just because you can identify the sentiment and the cause of the market movement it does not necessarily mean that you should try and trade it. Observing how things play out can be a very valuable learning experience.

Volatility

Sometimes understanding what is driving the markets is a good reason to stay out completely. A good example of this is when the markets are being driven by volatility. You probably have heard the term but may not fully understand it.

Volatility means that the price of the pair that you are trading is likely to move more than usual and in a less predictable manner. Volatility is usually connected to huge uncertainty or when the market really cannot tell what will happen next.

When the market is volatile it makes price action very difficult to predict meaning that one day the price may range and chop up and down in a tight range but then the next day it might rally twice its average daily range before selling off the entire move all for no obvious or apparent reason.

For example, in 2014 the Federal Reserve removed the word patient from its statement. This signalled to the markets that the Federal Reserve could act and raise its interest rate at any time and they would be basing their decision on the upcoming data from the U.S. If the data was good then they could potentially hike interest rates and if not this would cast doubts over the whole concept of hiking rates. They did this during the first quarter when most data points are adversely affected by the winter weather from previous months. This was enough to create huge uncertainty in the markets when the U.S. data started coming out worse than expected. The market kept questioning if it was due to a genuine slowdown in the economy or from the transient effects caused by the winter weather.

There was no easy answer in the moment so for around two months the markets were in utter chaos seeing the USD rise and fall almost randomly as traders tried to determine what was going on now and what might happen next. As the weeks played out and it became clear that the poor data was just a seasonal blip which allowed for normal trading to resume and the USD became supported as the markets expected the Federal Reserve to continue on its current path toward rate hikes.

By being tuned into what is happening it’s more predictable to perceive if the markets will likely be confused or uncertain about that type of situation and the best course of action is to simply sit out that whole period or trade currencies that offer a better level of predictability.

Volatility is one of the biggest killers for traders and it’s during these times that the most inexperienced traders get burned and lose money. It cannot be overstated how important it will be for you to be able to identify these periods of volatility and either switch to a different currency or avoid trading altogether. Developing this skill will be the difference between you keeping your profitability or having an overall loss over the long run.

Stop Hunting and Price Squeezing

You may have heard of stop hunting and price squeezing before but if not this is basically where we are hunted and played by other much larger market participants. This can sometimes feel like the market is trading personally against us and in a sense it is. Someone out there wants your money in their pocket, not in yours.

For example, imagine that you just entered a short position because you have a good fundamental or sentiment reason to anticipate a price drop on a certain currency pair. As you enter the trade you place your stop loss just above the most recent high because if you are correct about the trade the market will push the overall price lower rather than making fresh new highs.

What happens next is the price starts to rally sharply against your position until it breaks the high and stops you out for a loss. This is something that happens to many new traders and one of the reasons that traders think the market is out to get them. Then as if to insult you the price reverses and eventually declines to where your previous take profit area was.

If you have suffered this it can be extremely frustrating, but the next question is why did this happen if you were correct in your analysis? If the market wants to sell the pair why did it rally and stop you out first?

This is a classic example of something called a stop hunt or a squeeze as it’s also called. The reason that stop hunts occur is actually very simple and makes perfect sense when you know the details behind them. It is definitely not anything personal against you, it's just business.

Let’s look at this same trade from the perspective of a large fund or trading firm. Imagine that you are trading hundreds of millions of dollars in size and you also think that the price of a certain currency pair is going to fall. However, because you have such a large trade size to execute you can’t simply click sell because you will move the market sharply with your trade size. This will give you a bad price and take most if not all of your profit out of that trade which is no good and a terrible way to try and make a profit.

In order to get in the short trade at a decent price and to be able to make a profit on your trade you will need some extra liquidity. What you need is a pool of buy orders all near the same price that you can use to execute your large sell order. As you look at the pricing feeds you notice that all the sellers are placing their stop loss orders just above the recent highs. This makes all their stop loss orders buy orders which also happens to be what you need in order to execute your large short trade.

The major problem is that the price of the recent high is a few pips away from the current price and most traders are positioned as sellers. Because you are a large player with large funds available you can simply buy up the price to where the stop loss buy orders are. When the price gets there you can then execute your large sell order into all of the stop loss buy orders. This frustrates all retail traders but gives you the vital liquidity you need to place your order without slipping the price too far down. This helps to explain why stop hunting occurs.

As with all these concepts, being aware of this will help give you a much better chance at being profitable in the long run. For example, being aware of this will make you think twice about where you are placing your stops. Is it really a good place or is it where all the other traders will be placing their stops too? Do you want to get in where everyone else is getting in or could you take advantage of the stop hunts and get in at the same areas as the big players?

Considering these types of things will really help you develop your trading skill and take it to the next level. You should be placing your stop loss orders beyond where everyone else is because you don’t want to be a part of the herd that gets run over.

Sentiment as a whole is also very good for getting you into a position during a time when the underlying fundamentals may in fact be changing completely. Imagine if the data for a particular country has been getting worse and worse over the recent months and you have been trading the short-term sentiment generated by this. But you also realize that as it progresses this could in fact change the bigger picture forcing the central bank to change its policy and act in response to the new data sets.

One bad piece of data in a string of positive data releases does not change the overall fundamental picture. However, if the country had been producing 70% positive data sets for many releases but now has dropped to 30% over the last several releases then you may at some point have to consider if the economic situation is changing the underlying fundamental picture.

Sentiment is the perfect precursor for all of these events and by remaining tuned in to the shorter-term sentiment you can actually be fully prepared to act when the bigger picture changes. This is because you are watching the exact same indicators and events that the Central banks are watching. The central bank's reaction and views are rarely any different from the market reactions.

Profit Taking

Prices can’t continue to go up or down in a straight line forever. At some point price is going to need to take a breather and retrace some of the previous move. It’s in these times when nothing has happened to change the current sentiment, that the market or large market players may simply be taking some profits.

Traders love to ring the register and there is no better time than when the market has given them a nice extended move. As the market continues to move in one direction for a long enough period of time, more and more traders are going to start getting itchy fingers.

Profit Taking Example

Let’s say that there has been a nice 100 pip rally on the EURUSD currency pair because there was positive economic data out of Europe today. If the average daily range of the EURUSD pair is 80 pips then traders know that the move can’t continue on much further under normal circumstances. The more price rallies beyond the average daily range, the more likely it is that traders will start taking profits.

In order for the trader to take a profit they must sell what they already own. When enough traders start selling their long positions then this can cause the price to retrace. This is profit taking in its most basic form.

If price doesn’t retrace very much then this could mean that traders don’t really feel like taking their profits just yet; the reasons for being in the trade are still very strong. However, if you do get a profit taking retracement, and the sentiment has not changed from the original move, then this is a new buying opportunity to get back into the trade at better prices once traders finish taking profits.

Profit taking is interesting because it is a sentiment created from a previous sentiment. It is a sentiment created from the previous sentiment that moved prices far enough to create the need to take profits….which is also a sentiment!

Using News Feeds to Identify Current Sentiment

In this section, we will go over exactly how you can identify the prevailing sentiment, including all of the tools and resources that professional traders utilize, and how you can replicate that analysis.

The first question you might be asking is where do I start? You know all the different forms of sentiment and what drives the price but as you sit at your trading desk before the session opens, what should you be looking at in order to identify the specific reasons behind the price movements? Most importantly, how should you interpret this as the session kicks off?

Let’s begin by going through the tools that you will be using to identify sentiment and how you should be approaching these on a daily basis.

All professional traders use a real-time news feed and research analyst reports to give them an edge in deciding which way the markets are most likely to move next. The point of these tools is to get the trader up to speed quickly on what the markets are doing and what they are likely to do in the following session.

We will spend some time here going through exactly how this works and how you should approach it to get the maximum benefit. This is the exact same information that is being used by professional institutional traders all over the world.

You can view a list of news feeds and squawk services Here

Audio News Feed

The idea behind an audio news feed is to get market-moving news instantly without you having to personally sift through hundreds of various sources to read the information that is pertinent to your trading. There is a trained team of analysts behind professional news feeds watching the markets with access to every single professional news source available.

The costs of these sources alone equate to tens of thousands of dollars monthly. The analysts sifting through these feeds are trained to identify market moving events. Once they have been identified, these events are then communicated via the audio feature so that you will hear it immediately and can take instant action if necessary.

The purpose of the audio squawk is that only the relevant information is communicated so that you are not disturbed unless it’s of benefit to you and your trading. These squawks can happen at any time so it is best to have your audio turned on at all times when you are trading.

Text Feed

To complement the audio there is a comprehensive text feed that is constantly updated with everything that is squawked plus extra analysis and research for you to stay in tune with the changing markets in real-time. The text feed is there to feed you information about what the market is doing, what it is thinking, and how it is trading at any given time.

The news feed is your hub for information during the session and it is the first place that you should start each day when constructing your daily trade plan.

Along with the feed, you should also use your reading list and follow your online sources of information to give you an expanded view of what has happened and what is currently happening. You should also search out your own analysts to follow as they will give you a better variety of anticipated market reactions or even just a deeper understanding of what is happening overall.

For the first few months, it would be best to follow along with a professional trader as they analyze and interpret this news for you but over time you should start to develop these skills yourself and be in a position to be completely independent in your own analysis.

Professional traders are at their desks at least one hour before the session starts studying the previous session and researching the current market sentiment. This type of preparation should be part of your daily routine also. Once you then have this information you can then formulate your trade plan for the day.

Sentiment Trading Tools and Routines

In the following Wiki on Sentiment Trading Tools and Routines we will explore:

• Sentiment Trading Tools
• Sentiment Trading Routine
• Top Down Order to Apply the Routine

You can access the main Wiki on Sentiment Trading Tools and Routines HERE.

Related Wikis

Readers of Sentiment Analysis also viewed:

• Fundamental and Sentiment Trading Strategies
• Fundamental Analysis
• Risk Management
• Central banks
• Monetary Policy Tools