A sentiment trader analyzes signals related to others’ feelings about a market or asset. They use this information to make trading decisions. Sentiment traders consider the overall mood of forex brokers and investors before entering or exiting a position.
The mood or attitude is otherwise known as market sentiment and can be bullish (optimistic) or bearish (pessimistic).
Sentiment trading differs from technical analysis, which focuses on charts and patterns. It also differs from fundamental analysis, which looks at macroeconomic factors or a company’s health.
A sentiment trader cares more about how people feel about a market or asset. For example, are they feeling anxious, excited, fearful, or greedy?
Several ways sentiment traders measure sentiment include:
- The CBOE Volatility Index, also known as the fear index, measures market sentiment. High levels suggest heightened worries, while low levels indicate market complacency.
- The high-low index. The comparison looks at the number of stocks hitting 52 weeks high vs those at 52 weeks lows. An index below 30 suggests stock prices are near their lows, indicating bearish sentiment. Conversely, an index above 70 means prices are near their highs, signalling bullish sentiment.
- The bullish percent index (BPI). In neutral markets, the bullish % typically hovers around 50%. A BPI reading of 70%+ indicates positive sentiment, suggesting stocks may be overvalued. Conversely, a reading less than 30% points to negative sentiment, implying an oversold market.
- Moving averages (MA). Traders may rely on the 50-day and 200-day MAs to measure market sentiment.
- A “golden cross” occurs when the 50-day MA crosses above the 200-day MA. This signals upward momentum and a bullish outlook. In contrast, a “death cross” happens when the 50-day MA falls below the 200-day MA. It indicates a potential downturn and bearish sentiment.
The importance of sentiment in trading
Market sentiment has the ability to impact asset prices considerably. This often leads to fluctuations that may have little to do with fundamental data.
What does this mean though? Well, let’s take a company that is performing well. Even with strong financial results, a company’s stock price may still fall. This can happen if the broader market sentiment is negative, possibly due to economic concerns.
But more than this, having a solid awareness of sentiment may also help the trader to identify potential trends early, enabling them to position themselves in a way that increases their potential to profit from emerging trends.
This is because market sentiment often changes before price trends become visible on charts.
Secondly, by having a good understanding of the market’s mood, traders are better able to recognise emotions influencing price fluctuations, enabling them to become more objective when taking decisions.
Third, sentiment traders can also leverage market optimism or pessimism. For instance, when sentiment is excessively bearish, it might suggest that a market bottom is forthcoming, presenting a potential buying opportunity.
Who is sentiment trading best suited to?
There are many approaches to trading. Picking one usually depends on a person’s trading experience, goals, budget, risk aversion, and the time they have available to trade.
Some of the most popular trading approaches include day trading, position trading, scalping, swing trading, news trading, and so forth.
Sentiment traders are people who use sentiment indicators to understand the market’s mood and decide when to enter or exit a trade.
This can include day traders who rely on short-term sentiment changes to profit from quick price movements.
It also includes swing traders who look for sentiment changes over time to find medium-term trading opportunities.
Some key commonalities among sentiment traders:
Emotions Driving Market Decisions
- A keen interest in market and trading psychology to properly understand emotions and their influence.
- They have in driving market shifts and consequent trading decisions.
Combining Sentiment and Technical Analysis
- While they look to sentiment primarily, they’ll likely use technical analysis as well to spot entry and exit points that align with market sentiment.
Staying Informed on Market-Influencing Events
- Sentiment traders will be mindful to stay up to date on current affairs, particularly those events that have the potential to sway the markets.
- This includes geopolitical uncertainties, economic releases, earnings reports, news releases, environmental disasters, pandemics, war, etc.
Short-Term Opportunities vs. Contrarian Approaches in Sentiment Trading
- While some will focus on short to medium-trading opportunities that come about as a result of changes in market sentiment rather than long-trends, others may choose to adopt a contrarian approach which means acting against the existing mood of the market if they believe it to have reached an extreme.
Flexibility and Adaptability in Sentiment Trading
- Sentiment traders are also usually very flexible and adaptable. They understand emotions can change very quickly, and this extends to market moods.
- They adopt a flexible approach to be able to react to sudden shifts as they occur.
Risk Management Strategies for Sentiment Traders
- They are very aware that sentiment can change at the click of a finger and thus place great importance on implementing risk management techniques to safeguard their capital once trades are executed. These include:
- Continuous monitoring of sentiment indicators so that if a sudden shift in sentiment occurs, one that looks to go against an existing trade, can exit the trade timeously and limit losses. Setting stop-loss order to mitigate the risk of exponential loss.
- A sentiment trader will likely set the level at the point where they believe the sentiment shift will no longer support their trading strategy.
- Setting trailing stops during periods of strong positive or negative sentiment to maximise potential profits while reducing the risk of an unanticipated reversal. Adjusting position size (typically 1%-2% of their trading capital) based on their confidence in sentiment analysis.
- Diversifying their portfolio across various assets or industries to better handle a sudden shift in sentiment that may impact a particular market or instrument.
Acquiring a trading-related education
As with any trading strategy, to become a skills sentiment trader requires a good trading related education. This will ensure a solid understanding of what it is, how to implement it, the factors impacting it, and how to handle potential risks.
Learning comes in different ways, be this through blogs, articles, ebooks, podcasts, seminars, webinars, exhibitions, videos, Economic Calendars, Các công cụ tính trong giao dịch, and more.
It can also be achieved by participating in community forums to engage with other traders, share ideas, insights, and concepts, and generally garner information that you may otherwise have not had access too.
Additionally, signing up for a demo trading account is another good opportunity to learn how to trade in real life market conditions but within a simulated trading environment, using virtual funds, keeping your own money safe as you get educated.
How Sentiment Traders can Start with T4Trade
T4Trade is a popular global broker with clients worldwide. The broker offers top-tier, 24/5 multilingual customer support, cutting-edge trading platforms, and flexible trading conditions.
T4Trade is also a great go-to resource for traders looking to learn more about CFD trading in a user-friendly way.
A variety of videos, podcasts, eBooks, webinars, and videos-on-demand are curated by in-house specialists, catering to all types of traders.
T4Trade traders can also choose from a wide range of trading instruments across 6 asset classes, and enjoy flexible leverage, competitive spreads, fast trade execution and seamless deposit and withdrawal options.
Traders can also choose from multiple trading accounts that best suit their needs and individual preferences.
Khước từ trách nhiệm: This material is for general informational and educational purposes only and should not be considered investment advice or an investment recommendation. T4Trade is not responsible for any data provided by third parties referenced or hyperlinked in this communication.
