Understand the mood of the market
Emotions are the key to understanding financial markets. However, it’s tough to make rational decisions based on them. Even if you think you read your emotions or other peoples emotions, you may get lost in trying to comprehend the feelings of the crowd. And the market sentiment is the emotions of millions of traders around the world.
Every trader knows the importance of emotions. You can see it in market volatility.
The two most dominant emotions
Fear and greed are the most dominant emotions among traders. They are either afraid of losing money, or they want to earn more. Greed is overwhelming at market peaks when the bubble is created.
On the other hand, fear takes over when the market hits bottom. Traders are panicking underestimating the real value of an asset. A savvy investor can see an opportunity for opening a long position in these situations. However, trading against the trend always involves high risk.
How to identify fear or greed? When you see a trend accelerating breaking new resistance levels without any fundamental explanation - no critical information that would justify it - you may expect the greed is in action. The same mechanism works the other way around with fear. If during a downtrends support levels are broken without an apparent reason, the fear may have taken over.
The market sentiment is very easy to read if you take a look back. Everything seems to be visible. Even if you are new to trading, you can easily spot greed taking over just when the bubble is about to burst. However, at the time of the bubble, hardly anyone notices it, even the wisest and most experienced traders.
It’s difficult to profit directly from fear or greed taking over. Even if you can read the past and present sentiment correctly, you need to know what the collective traders’ mood will be like tomorrow. Without any insider knowledge or ability to influence the prices with your trading volume it’s impossible to do it repetitively.
What is the best market sentiment strategy?
The best market sentiment strategy is keeping away from it. If you don’t use the most popular technical analysis tools and don’t trade reversals, you can avoid the riskiest moves.
Don’t chase the sentiment.Doing so you could develop a sustainable trading strategy with the right mixture of technical and fundamental analysis.