Market sentiment emerges as collective consequences of various factors, including fundamental and technical factors, chart patterns and important global news, among others.
In the forex market, price fluctuations often turn the market upside down in a seemingly erratic direction. This is due to market sentiment and the influence of economic fundamentals. However, what is market sentiment? What effect does it have on our trades? How to measure it?
What Is Market Sentiment?
Market Sentiment is an unofficial consensus among market participants (traders and investors) related to market assets and the macroeconomy. This unofficial consensus is an accumulation of various fundamental and technical factors, including price patterns and the release of economic data or global news that are considered important. These factors together form the general perception of the investment market community.
Every trader has their own opinion about the market, such as:
"Wow, market sentiment is so bullish after COVID vaccine introduction."
"Gold prices soar due to risk avoidance on North Korea conflict,"
and so on.
Opinions from all traders in the world go together to create "market sentiment".
Each trader has their own ideas on why prices go to a certain direction and where prices would go onward. Their opinions may differ from each other. Some of them may be right, while some others got it wrong. Because individual opinion only matters as a part of the general trend.
Important Terms Related to Market Sentiment
There are several popular jargon regarding market sentiment. The most common terms are "bullish" and "bearish" sentiment. Rising prices show that the market sentiment is bullish while falling prices are bearish. But that is not all; here are four terms you need to learn:
- Bullish Sentiment: Market participants are optimistic about an asset, so they buy and buy and elevate the price of the asset.
- Bearish Sentiment: Market participants are pessimistic about an asset, so they are busy selling it and pushing prices down.
- High Risk Aversion, Low Risk Appetite: There is an increase in risk in the market, so investors and traders are busy securing their funds in low-risk and safe-haven assets such as Gold, US Government Bonds, Japanese Yen, and Swiss Franc.
- High Risk Appetite, Low Risk Aversion: Uncertainty and risk in the market tend to decrease, so investors and traders dare to invest in higher-risk assets, such as stocks, emerging currencies, crude oil, and so on.
Why Should We Learn Market Sentiment?
As a trader, one of your responsibility is to learn about market sentiment. You can't tell the market what you want, but you can react to what's happening in the market. Market sentiment is such a powerful driver that it can influence the direction and movement of the market.
Various media show that market sentiment is indeed very dominant in influencing the dynamics of market movements. Negative sentiment will weaken the price of an asset, while positive sentiment will strengthen price movements.
For example, if there is a dominant factor in the market which then forms a bearish sentiment, market participants must expect falling prices right away, which prompts them to immediately take appropriate action. The definitive action can be profit-taking, hedging, or selling a number of assets. On the other hand, investors' fast responses by themselves actually accelerate price movements. The downward trend can be sped up by the spread of information about this bearish news.
How to Measure Market Sentiment?
Basically, experienced traders and investors will be able to measure market sentiment using intuition. Certainly not a random insight, but derived from long experience and in-depth observation of market behavior.
Users of Price Action analysis will observe market sentiment through changes in candlestick formations on historical charts. However, the indicators that are widely used by traders to monitor market sentiment are weekly Commitment of Trader (COT) data released by the US Commodity Futures Trading Commission (CFTC), as well as Buy/Sell ratios that are sometimes displayed by certain brokers.
Another one that is often used to measure market sentiment is the VIX. However, this is a mistake. The VIX (Volatility Index) was created by the Chicago Board Options Exchange (CBOE) to measure the stock market's expectation of volatility based on S&P 500 index options. It is often used to measure market volatility in general, but it is not a market sentiment indicator per se. If the VIX goes up, it means that there is an increase in uncertainty, while if the VIX goes down or the value is low, it means that market confidence improves.
In short, market sentiment is an important part of the market itself. For an investor, market sentiment analysis includes understanding the emergence of sentiment, how it changes from time to time, also how to profit from existing and subsequent sentiment.
Sentiment emerges as collective consequences of various factors, including fundamental and technical factors, chart patterns, economic data releases and important global news, as well as market cycles. Thus, we have to study a lot of information on financial markets in order to learn it well.