How to Use Market Sentiment to Trade the Markets
Online Trading Demo Account: For upon |The ebbs and flows of daily market movements are driven by market sentiment. Over the long term, fundamentals will drive the price of an asset such as a currency pair or equity index, but over the short term, markets are driven by sentiment. There are several tools that you can use on an online trading platform to measure market sentiment. You can use a sentiment as a contrarian indicator or a momentum index. Here are a few sentiment methodologies that can help you determine market sentiment. Online Trading Demo Account.
The VIX
If you are trading the equity markets, which includes, indices, shares, and ETFs, the VIX volatility index is a great tool to use to determine sentiment. The VIX volatility index tracks the movements of the implied volatility of the “at the money” strike prices on the S&P 500 index. The VIX is considered a fear gauge. As the VIX climbs, the price options traders need to pay for protection increases. This is because the value of the premiums needed to purchase options rises as implied volatility rises. Online Trading Demo Account.
To use the VIX as a sentiment indicator you can view sentiment as complacent and too optimistic when the VIX is relatively low. Fear is baked into the VIX when the index climbs too high. Online Trading Demo Account.
The Commitment of Traders Report
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Another sentiment indicator that you can use is the commitment of the trader’s report. This is a weekly report produced by the Commodity Futures Trading Commission. The report shows you the net long positions and short positions held by swap dealers, managed money, and other reportable. Positions that are reported on by the CFTC are futures positions. The CFTC is the regulator that oversees the US futures market. Generally, swap dealers cater to commercials that are hedging their exposure. For example, an oil producer would transact with a swap dealer to hedge their oil risk. Online Trading Demo Account.
The best sentiment gauge is looking at the Managed Money report. If managed money is much longer than short, hedge funds that are long a commodity could be subject to liquidation. The reverse is true if managed money has a large net short position. In this case, they would be subject to a short-squeeze. The commitment of traders‘ reports is a very good contrarian indicator. Online Trading Demo Account.
A technical Indicator
Another very good sentiment indicator is a technical indicator called the relative strength index (RSI). The RSI is a momentum oscillator that can be used to measure overbought and oversold conditions. The relative strength index was developed by J Wells Wilder and helps measure market sentiment. The RSI measures a 14-period timeframe and generates an index between 1 and 100. Reading on the RSI above 80 is considered overbought and therefore sentiment is too bullish. Reading below 20 is considered oversold and therefore sentiment is considered too bearish. Online Trading Demo Account.
By using different sentiment indices you can determine if an asset is poised to move quickly in a specific direction. The VIX volatility index, the commitment of trader’s report, and the RSI provide you with specific information that you can use to determine if sentiment is overextended.
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