Weekly Trading Lesson: The SSI - What Everybody Else is Thinking

One of the most popular benefits of taking one of the FX Power Courses that FXCM offers is that graduates who are also live clients receive a year of email support from the instructors and can ask any trading related question they have. Since we are all active traders, many new traders ask if we have any secrets that we can share with them to help them become better traders. I have one that I would like to share with you. It is the SSI or the Speculative Sentiment Index and it may be one of the most valuable tools for FX traders to use when searching out trading opportunities. It is put together by the research analysts here at DailyFX and I start every trading day by reading it. What is the SSI? Here is the explanation from DailyFX:

[B]The FXCM SSI[/B] is based on proprietary customer flow information and is designed to recognize price trend breaks and reversals in the four most popularly traded currency pairs. The absolute number of the ratio itself represents the amount by which longs exceed shorts or vice versa. For example if the EURUSD ratio is 2.55, long customer orders exceed short orders by a ratio of 2.55 to 1. Conceptually similar to contrarian analyses using the CFTC IMM open position data or COT Report, the SSI provides an alternative approach that is both more timely and accurate in forecasting currency price movement. The SSI is a contrarian indicator that tells you how the market is weighted and where the trend may head. More long positions don’t necessary suggest more confidence in the direction of the current trend. In general, when traders start having adverse movements against their position, many tend to increase the size of their position with the purpose to average down their entry price in one last attempt to recover from previous losses. However, the higher the number of short orders in a bull market the more dangerous is to take additional shorts because many of those traders who just entered the markets are also leaving their protective stop losses just above the current price action. What this means is that traders are most wrong when holding extreme positions one way or the other. If traders are heavily long (buyers), then the market has a tendency to sell off and if traders are heavily short (sellers), then the market has a tendency to rally. This is not because traders are always wrong, but rather if everyone has already bought, then there is no new money to continue to push the market up and it falls instead. So we want to look for the currencies that are at extremes. At the bottom of this page you will see a typical weekly report put out by the DailyFX research staff. We can see that the EUR/USD and the GBP/USD are bullish because more traders are sellers than buyers while the USD/CHF and USD/CAD are bearish because more traders are buyers than sellers. The USD/JPY is about even and not at an extreme at all. I consider an extreme reading to be when the ratio of buyers to sellers is above 3 or below -3. The biggest ratio is on the USD/CHF where the ratio was 4.49. Here is what the accompanying report said about this pair:
USDCHF - The ratio of long to short positions in the USDCHF stands at 4.49 as nearly 82% of traders are long. Last week, the ratio was at 3.70 as 79% of open positions were long. Retail traders have been buying the USDCHF and long positions are up by 20.7% since last week. The SSI is a contrarian indicator and signals more USDCHF losses.
This was from the report dated July 5th, as seen below, while the USD/CHF was trading at 1.2171. Within a week the USD/CHF had sold off to down below the 1.2000 level, confirming the value of this tool that is only found at FXCM. Live clients can find twice daily reports at DailyFX + under the Intraday Analytics section found within www.fxcmtr.com. Others can see a weekly update at www.dailyfx.com.