The following is a guest editorial courtesy of multi-asset global broker Admirals.
When discussing technical indicators for trading financial markets, we immediately think about the technical indicators placed on our trading charts. Indicators such as Bollinger Bands, MACD, RSI and PSAR have become increasingly popular over recent times.
Market sentiment is one of the key pillars underpinning most asset markets, and market sentiment is the ultimate demonstration of crowd behaviour. If that crowd rushes in one direction and the group grows, then (in theory) markets can move.
A popular technical indicator termed the Elliot Wave has been used for decades to pinpoint such crowd dynamics. But like many indicators, it lags; it doesn’t lead. It tells you what has happened, not what will happen next, a common fault with most technical indicators.
Elliot Wave theory might illustrate one critical fact; are you or will you be on the right side of the market? It can’t tell you when the market suddenly turns because it can’t tell you what percentage of the market is long or short at any snapshot in time.
The Admirals sentiment tool
Over recent years technical indicators have evolved, and some are hybrids between fundamental and technical analysis. The Admirals’ sentiment widget for forex pairs and gold is an excellent example of this union.
https://admiralmarkets.com/analytics/market-sentiment
We know we must develop fundamental and technical analysis skills to succeed in the FX trading industry, but sometimes we can be guilty of overcomplicating the science.
We might duplicate some indicators on our charts and curve fit the past data to match our expectations. But with something as black and white as a sentiment widget, you can’t do this.
How the sentiment widget works
Admirals and other brokers have their trade execution data screened by a service company called FX Blue Labs, and brokers can even choose to have a live feed delivered to FX Blue. FX Blue then aggregates the data and publishes the sentiment pie-charts in an easy-to-read format.
Traders can quickly visually analyse the weight of sentiment in, for example, major currency pairs like EUR/USD and minor pairs such as AUD/JPY.
The data only covers the most traded pairs, as information is intermittent and random for the more exotic currency pairs. You can see what the sentiment is relating to a currency pair expressed as a percentage.
How to use the sentiment widget
Your interpretation skills are needed to analyse the percentage readings as part of your overall trading plan. You’ll need to decide which percentage reading is your action point.
It’s clear that a 50-50% balance is the sentiment for a currency pair balanced on a knife-edge, but what about 60-40%?
You also must consider how quickly that sentiment has changed. Has the 60-40% distribution been in place for several days, suggesting a currency pair stuck in a range or is it continuing to trend in the current direction?
A sentiment widget is a tool best used in conjunction with others; it would be unwise to use it singularly as a standalone sign of a security’s value in the marketplace.
However, concentrating on its single purpose could prove incredibly valuable, particularly in a trading strategy based on probability and underpinned by risk.
Let’s say you’re a swing trader and use the widget. You have a simple rule; you never take a trade opposite the current dominant sentiment. If traders are long, you don’t go short, and vice-versa.
Or you could use the sentiment widget as your final decision-maker. For instance, you use a four technical indicator strategy, and all the indicators align, encouraging you to take the trade. But before you execute the transaction, you take a final look at the sentiment reading to confirm your decision.
Another advantage of the sentiment widget is for showing FX correlations. We know that USD/CHF moves in a negatively correlated pattern to EUR/USD most of the time. The sentiment reading might confirm this and indirectly discourage you from taking trades that don’t correlate. For instance, is there any value in being long EUR/USD but short GBP/USD?
Is there a downside?
Like all widgets and tools, it’s not perfect, and it has limitations. The most critical is that 90% of trading in the FX market is institutional; therefore, the service provider can’t tell you where Morgan Stanley and Goldman Sachs’ clients have positions.
So, you could extend your sentiment reading analysis to include the COT (commitment of traders) report published at the end of each trading week.
https://www.cftc.gov/MarketReports/CommitmentsofTraders/index.htm
Most banks and hedge funds declare their market positions, and you can read the sentiment. If the sentiment widget readings aren’t that different from the institutional COT positions, you might regard the sentiment widget as accurate.
You also need to set up the time frame of the sentiment widget reading. The COT report is beneficial for position traders, not scalpers or day traders. The COT readings tend to turn like oil tankers, not water-skis.
Admirals has a library of analysis you should take a closer look at
A click on the analytics section of the Admirals website reveals a comprehensive library of valuable features and widgets, and traders shouldn’t overlook the volume of articles published by their leading analysts.
https://admiralmarkets.com/analytics
In this section, you’ll find a heat map, podcasts, economic calendar, trading central, and columns concentrating on fundamental and technical analysis.
All this multi-layered contribution is there for one specific reason, to encourage traders to better themselves through a dedicated and disciplined approach to market trading.
About Admirals
Founded in 2001, Admirals is a multi-award-winning online financial broker offering competitive spreads and low commission charges. Admirals offer trading in Forex and CFDs on multiple products, including energies, stocks, bonds, ETFs, indices, and metals.
Through Admirals, traders can access high-tech platforms such as MetaTrader 4 and 5 on the web, mobile, and desktop for the ultimate trading experience. The mobile platforms are enhanced for iOS and Android, and clients can also access a proprietary plug-in called MetaTrader Supreme Edition.
Admirals’ clients get free access to webinars, seminars, and videos. Clients can trade from 150 countries and select from a wide range of accounts based on the software platforms clients prefer, their experience and their financial circumstances.
As a regulated broker, Admirals have approval and licenses in many jurisdictions, including Financial Conduct Authority (United Kingdom), Cyprus Securities and Exchange Commission (Cyprus), Financial Supervision Authority (Estonia), Australian Securities and Investments Commission (Australia), Financial Services Authority of Seychelles (Seychelles).
Clients can fund their accounts through Credit/Debit Card, Bank Wire Transfer, PayPal, Skrill, Union Pay, Neteller, AstroPay, and Trustly.