Sentiment, or market sentiment, refers to the highly subjective feeling about the state of a market.
Market sentiment represents the mood of financial markets and the general feeling among traders, whether they trade the forex market, the stock market, the bond market, the crypto market, or other markets.
If you are a short-term trader, it’s definitely a good idea to be in tune with how the market is feeling.
Market sentiment, which is often in reaction to the news, can play a major role in driving currency prices.
Each trader’s thoughts and opinions, which are expressed through whatever position they take, helps form the overall sentiment of the market regardless of what information is out there.
Understanding sentiment allows you to judge whether a market is feeling optimistic or pessimistic about the future of prices of an asset, such as a currency.
Ultimately though, sentiment is expressed in the price action.
Sentiment is what creates supply (selling) or demand (buying) for a currency.
If traders believe that a currency is headed in a certain direction, they will trade accordingly and may convince others to follow suit, increasing, or decreasing demand.
Market sentiment is considered bullish when prices are rising and bearish when prices are falling.
Gauging market sentiment can be a challenge though since it is a result of multiple factors.
While they are closely related, it is worth noting that market sentiment and fundamental analysis are quite different things.
While the sentiment is related to psychology and emotions, fundamental analysis is a way of looking at the forex market by analyzing economic, social, and political forces that may affect currency prices.
Fundamental analysis shape sentiment. While sentiment analysis determines whether the market is bullish or bearish on the current or future fundamental outlook.
One of the most important things for traders is to identify the real reasons why the market is moving in a certain way.
The underlying fundamentals tell why something is moving a certain way over the medium to long term. The sentiment tells them why things are moving in the short term.
Many traders consider the market sentiment to be a good indicator of potential short and mid-term price movements.
That said, you can never really know with 100% certainty when sentiment will change or end.
Just like the moods of individual people, sentiment in the FX market, and the overall financial market, can change quickly and for a variety of reasons.
Sentiment can last anywhere from a few seconds to a few months depending on how strong a particular sentiment is.
If you are a short term trader, identifying the prevailing sentiment should be a priority.
Why? Because any change in market sentiment can have a very significant impact on any trades that you may have open at any given time.
Greed and Fear
Market sentiment can be seen as the result of the two major emotions that drives a financial market: greed and fear.
The dominant feeling in the market usually dictates the overall sentiment of a market.
Most traders are conditioned to follow the general direction of prices, but eventually, the bullish or bearish price movement will peak.
In general, when the sentiment is overly optimistic (bullish) or pessimistic (bearish), the market tends to reverse and start moving in the opposite direction.
In other words, the market tends to go up when the majority of traders are bearish, and down when the overall sentiment is more bullish than what could be considered normal
Used this way, sentiment works as a type of contrarian indicator.
The market sentiment is one of the things contrarian traders look for.
If most people are bullish, they will consider selling or going short. But, if the sentiment is too bearish, they will consider buying or going long.