thinking or feeling about the market – it is the most important factor that drives the
currency market.
This is so because traders tend to act based on what they feel and think of certain
currencies, regarding their strength or weakness relative to other currencies. I will
assume that when you trade currencies, you don’t blindfold yourself to simply pick
any pair to buy or sell, leaving it to randomness to determine your profit/loss
statement at the end of the day or month.
Market sentiment sums up the overall dominating emotion of the majority of the
market participants, and explains the current actions of the market, as well as the
future course of actions of the market. The trend adopted by the forex market is
actually a reflection of the current market sentiment, which in turn guides the
trading decisions of other traders, whether they should long or short a currency pair.
In the process of making educated trading decisions, traders have to weigh a
multitude of factors which could influence the bias of a currency, before making up
their minds about the current and future state of certain currencies. One thing to
note is that market sentiment is not logical; it is primarily based on traders’
emotions, which is really one of the greatest, if not the greatest, factor in the
determination of a currency exchange rate.
There are three main types of sentiment when it comes to forming opinions in the
forex market:
1. bullish,
2. bearish or
3. just plain confused.
If the majority of the market wants to sell that currency, the market sentiment is
deemed to be bearish; if the majority wants to buy that currency, the market
sentiment is bullish; and when most market participants are unsure of what to do at
the moment, the sentiment ends up being mixed. Since the US dollar is the currency
on the opposite side of 80% of all foreign exchange transactions, most traders will
be concerned with what the market thinks about the US dollar. Currency prices
simply embody the market’s perceptions of reality and the sum total of
traders’ emotions.
Market sentiment acts like a fickle lover, capable of changing its mind based on
certain incoming new information which can upset the existing sentiment. One
moment everyone could be buying the US dollar in anticipation of a stronger dollar;
the next second they could all be dumping it as they fear the dollar would start to
weaken due to the impact of some new piece of information, which is almost
always some fundamental news.
Understanding the current market sentiment and exploiting it appropriately with the
other strategies discussed in this book can help maximise your trading profits,
because if you can guess what the other market players are thinking about, and
understand why the market is doing what it is doing, you will be in a better position
to plan your entry and exit points and timing.
Source: 7 Winning Strategies for Trading Forex: Real and Actionable Techniques for Profiting from the Currency Markets
