In the previous article, we mentioned that there are several kinds of analysis in forex trading. We have talked about the fundamental analysis that focuses on economic data and news, as well as the technical analysis of price movements and chart patterns. Today, we are going to introduce the market sentiment analysis, which is more from a psychological viewpoint, and how to apply some popular market sentiment indicators in daily trading.
What is market sentiment?
In the financial markets, the behavior of investors is often driven by psychological expectations. Generally speaking, when the majority of traders have similar thoughts and behavior patterns in a given period of time, the balance of the bull and the bear will be biased to one side, and an upward or downward trend will naturally develop under the impetus of the market forces. Market sentiment is all about collecting the thoughts and behaviors of investors in the market.
We can predict the direction of the stock market or the Forex market by market sentiment. Assuming a bullish trend in the U.S. stock market in the near term, it can be interpreted that traders are optimistic about the economy and therefore the stock market is likely to perform well, so the traders are likely to go long and further push up the stock price.
Figure 1: Common long-short position ratio chart (source: fxssi.com)
The chart above shows the most common position statistics of forex traders. This is the most elementary market sentiment index, which uses the distribution of long and short positions to gauge current market investor positions and speculate on further market movements. However, in general, the statistics of each forex broker may not be accurate and only include clients of a single platform, so it is recommended to only use it as a reference.
What advantages can market sentiment indicators bring?
Extrapolating future trends from market sentiment are simple and straightforward and can be easily understood by a novice. The more investors participate in the market and engage in similar behaviors, the greater the force generated by market sentiment, and the easier it is to create a bull or bear trend.
Therefore, if you can make good use of the market sentiment indicators in forex trading, you can usually avoid sudden trend reversal.
More advanced traders can use the details in reports, such as position changes in CTFC, to make excellent trading decisions and take the lead.
Common market sentiment indicators: Fear Index & CTFC Reports
Having briefly discussed market sentiment analysis and the advantages it can bring to trading, let’s take a closer look at two of the most common and credible market sentiment indicators: the VIX fear index and the CTFC weekly position report.
Although the objectives of VIX and CTFC position reports are to predict whether the trend will continue or reverse, their research subjects are different. VIX studies investors’ reactions to market fluctuations, while CTFC reports study the actual trading behaviors of traders.
1 / VIX – Volatility Index (Fear Index)
Although VIX is commonly known as “fear index“, in fact, it does not mean that when VIX rises, the stock market will definitely fall. Rather, VIX represents the increase in volatility. In other words, once the VIX rises, the probability of sharp volatility in the stock market will increase. On the contrary, if the VIX hovers at a low level, it indicates that recent volatility may be relatively low.
As the VIX is used as a reference for the stock market, its comparative model is the S&P 500 index. Therefore, traders can take the trend of VIX as a reference for the rise and fall of the stock market, and try to increase the possibility of profits from the opportunity of large fluctuations.
VIX can also be used in forex exchange and precious metal trading. When VIX rises, the chances of gold price and US dollar appreciation will also increase.
Figure 2: VIX Index and the S&P 500 go opposite (Source: Investing.com)
It can be seen from the figure above that VIX rose rapidly after February, indicating that the stock market may have a large price change. Compared with the changes in S&P 500 to the right, there was a rapid fall, reflecting that when VIX rose sharply, the scope and intensity of the stock market fluctuation would be greater. The subsequent slow drop in VIX suggests that stock market may stabilize before starting to rebound upward. Therefore, mastering the changes in the VIX can help investors accurately predict the subsequent ups and downs of the stock market.
2 / CTFC weekly position report
CTFC refers to the Commodity Futures Trading Commission. CTFC’s weekly position report is officially certified, so its credibility is very high. The participants of the report are as follows:
- Non-commercial traders: investment funds, hedge funds, private equity funds and other institutions that are mainly speculative in nature.
- Commercial traders: traders who trade for the purpose of avoiding risks, such as companies
- Retail traders
The application of the CTFC report is to use the changes of non-commercial traders‘ positions to form reference trading information, so as to assist investors to study and predict the market trend. The most important reference is the change of “speculative net positions”.
Figure 3: CTFC weekly report – gold futures
We can learn that the above figure that the long positions of managed money on gold have decreased by 4,402 lots and the short positions have decreased by 2,148 lots, which resulted in 95,438 lots net long positions. This suggests that these funds are still bullish on gold prices in the future, so investors can reasonably predict that the probability of gold price rising in the future will be higher. Therefore, going long in accordance with the trend will be a better decision.
Click here to read the lastest CTFC report.
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Risk Warning: The above content is for reference only and does not represent ZFX’s position. ZFX does not assume any form of loss caused by any trading operations conducted in accordance with this article. Please be firm in your thinking and do the corresponding risk control.
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