The world of trading is broad, long, deep, full of technical jargon, complex analysis and tools that are a challenge for the mind. The reality of this world, however, is that it is centered on the human being, which has its own set of complexities. The world of trading is made up of simple humans buying and selling in the markets, which can make them predictable in a general sense. This makes the people themselves one of the best indicators that we can use. This is clearly exemplified in the following phrase attributed to Warren Buffet:
When others are greedy, be careful, when others are careful, be greedy – Warren Buffet.
In short, in the end much of what happens in financial markets like the Forex, stock market, futures, commodities, etc., is due to what is known as market sentiment . Before explaining why this concept is so important, let us explain what it is and what it actually serves.
What is the market sentiment?
Market sentiment is the general sentiment or attitude of investors about the market climate as expressed by the direction of prices at any given time.
How functional market sentiment (Example)?
Market sentiment, as the name implies, describes the prospects of investors in a market. Market sentiment is most evident in general price trends. For example, rising prices suggest an optimistic (bullish) market sentiment , and falling prices suggest a negative (bearish) market sentiment .
Because it is important?
The nature of market psychology suggests that any given trend may be more indicative of market confidence than of fundamental gains or losses in the value of shares or other financial assets.
As a result, market prices are not necessarily indicative of the fundamental value of an action, but rather the attitude or beliefs that investors have about that action.
Although Buffet is not a trader, he is undoubtedly the best investor of our times, so his words about it should always be considered. One thing successful traders say is that having an understanding of the big picture of the market is an important key to having steady long-term gains. The elements to have this “big picture” are many, one of them being the feeling, that is the predominant voice of the people. However, sentiment can be a two-edged sword, but if one learns to read it correctly, it can be a valuable indicator in our arsenal of trading tools.
If we apply Buffet’s words in trading, we can say that if the general feeling is to pursue the market, it is best to sell. For example, just remember what happened with the technology sector in 1999 ( the bubble dot.com ). Or what happened with oil in 2008. We can also mention gold today, is it still a good asset to trade? Many successful traders operate against the prevailing sentiment, a practice that is quite common today. The reality is that everything that goes up has to go down and vice versa. What moves prices in markets in one direction or another is the common belief of investors about the value of a particular asset. It is these perceptions that create the movements in the short, medium and long term.
For example, the most common cause of low prices on the market is pessimism. The general sentiment before the market begins to move is another indicator that we must take into account. That sentiment is measured by surveys and confidence indexes of which there are many, but some are key, such as the weekly survey of the American Association of Individual Investors (AAII), which takes into account the opinion of its 150 000 members about whether the market will be bullish, bearish or neutral. Another important survey is Investors Intelligence, which subjectively measures the sentiment of about 130 investment bulletins. Every week, Market Vane surveys the top market and commodity traders.
Each of these indicators is useful by itself, but together, they form a solid indicator that every trader should observe. Never forget that the market moves because people make it move. Therefore, the best indicator is one that follows people’s perceptions and beliefs. If you think about it carefully, this is what all indicators are really trying to do.