How to measure market sentiment
Market sentiment is a generalization of the overall dominating emotion of the majority of traders, investors. It determines the current trend of the market, as well as helps to identify the future path of the quotes and build a savvy trading strategy. As a rule of thumb, if the majority of the market wants to sell a certain currency, the market sentiment is deemed to be bearish; if most of the market participants want to buy the currency, the market sentiment is bullish. Market sentiments are fickle as the wind. They tend to change based on constant incoming news flow, economic release. Understanding the current market sentiment and exploiting it accordingly is a cornerstone for success in financial world. Here arises a big question mark. How to know/to measure dominant market sentiment?
Well, there are two well-proved ways of gauging market sentiments. With one of them you are already familiar – watching news reports. About another one, you might read for the first time in this article.
I am having in mind the Commitment of Traders report.
The COT report provides compiled, exhaustive open interest information about futures market. It is released by the Commodity Futures Trading Commission every Friday at 15:30 EST. You can get access to this report clicking this link: http://www.cftc.gov/MarketReports/CommitmentsofTraders/index.htm
It is a very useful trading information that can potentially maximize your profits because skimming through the report you can understand what the other market participants are thinking about the current state of affairs. Then, based on the information you’ve received, you can easily plan the entry and exit points. The only handicap of this sentiment tool is the time lapse between the reporting and release (three-day difference). But even with this flaw you still can get the general idea of the price directions in different currency crosses, aren’t you?
This is how the COT report looks like
You should focus your attention on the data presented in the columns titled as “asset/manager institutional”, “leveraged funds”, “other reportable”. These groups of market participants include those who use currency for speculative purposes. Also, you can take into consideration the data presented in the column “non-reportable”. These market players are retail traders. When a particular currency is trending up against the US dollar, a net long position is registered. A short long position is registered when the currency is trending down against the greenback. The tables and charts presented on the COT official website are really clumsy. Let’s say, they are not user-friendly. Many banks present the same information in a more attractive way in their weekly forecasts. The novice traders tend to omit these useful sources of information while reading the banks’ forecasts. So, next time, you look through them, pay attention to this COT info. It is really valuable for position sizing.
Of course, the COT data itself is not sufficient to generate entry and exit signals, but it may give us warning signals of a possible reversals in the spot forex market.