Sentiment

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 are involved in 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 beneficial to be aware of the market's emotional state. Market sentiment, which often reacts to news, can significantly influence currency prices. Each trader’s thoughts and opinions, expressed through their positions, contribute to the overall sentiment of the market, regardless of the available information.

Understanding sentiment allows you to assess whether the market is feeling optimistic or pessimistic about the future prices of an asset, such as a currency. Ultimately, sentiment is reflected in price action. It is what generates supply (selling) or demand (buying) for a currency. If traders believe a currency is moving in a particular direction, they will trade accordingly, potentially persuading others to follow, which can increase or decrease demand.

Market sentiment is considered bullish when prices are rising and bearish when prices are falling. However, gauging market sentiment can be challenging, as it results from multiple factors. This may include insights from fundamental analysis (FA) and technical analysis (TA) indicators, with recent news also playing a role.

While closely related, market sentiment and fundamental analysis are distinct concepts. Sentiment is tied to psychology and emotions, whereas fundamental analysis examines economic, social, and political forces that may influence currency prices. Fundamental analysis shapes sentiment, while sentiment analysis assesses whether the market is bullish or bearish regarding the current or future fundamental outlook.

One of the key tasks for traders is to identify the true reasons behind market movements. The underlying fundamentals explain why something is moving in a certain direction over the medium to long term, while sentiment reveals why things are shifting in the short term. Many traders view market sentiment as a valuable indicator of potential short- and mid-term price movements.

That said, it is impossible to know with 100% certainty when sentiment will change or end. Similar to individual moods, sentiment in the FX market and the broader financial market can shift rapidly for various reasons. Sentiment can last anywhere from a few seconds to several months, depending on its strength.

For short-term traders, identifying the prevailing sentiment should be a priority. Why? Because any change in market sentiment can significantly impact any open trades at any given time.

Market sentiment can be viewed as the outcome of two primary emotions that drive financial markets: greed and fear. The prevailing emotion in the market typically dictates the overall sentiment. Most traders are conditioned to follow the general price direction, but eventually, bullish or bearish movements will reach a peak.

Recognizing when that peak occurs is crucial to avoid buying at the top (due to greed or FOMO) or selling at the bottom (due to fear or FUD). Generally, when sentiment is excessively optimistic (bullish) or pessimistic (bearish), the market tends to reverse and move in the opposite direction. In other words, the market often rises when the majority of traders are bearish and falls when the overall sentiment is more bullish than what could be deemed normal.

In this context, sentiment acts as a type of contrarian indicator. Market sentiment is one of the factors that contrarian traders monitor. If most traders are bullish, they may consider selling or going short. Conversely, if sentiment is overly bearish, they may contemplate buying or going long.