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We have a good question here from a new subscriber asking whether they can and ever should trade against a currency’s, fundamental bigger picture buyer.
So, great question. The quick answer is yes, most definitely you can and the way we do that is with something called sentiment. So think of the fundamentals in various timeframes, right?
So at the top you have your macro economic fundamentals that is more your medium to longer term view. Think of this as your top down analysis. so to speak, starting with the overall economic outlook and working your way down to things like monetary policy, etc. And then we have something called sentiment.
Now, think of sentiment as your bottom up analysis, so to speak. So, that looks at the most current recent short term influences on the currency.
Now keep in mind, this can also certainly be a macroeconomic fundamentals that can act as a catalyst for sentiment, but it can also be very wide ranging catalyst, anything ranging from fiscal policy to politics, to cross asset correlations, risk sentiment, technical levels, et cetera. So think of the sentiment as the market’s current mood about any particular currency based on a particular catalyst.
So a quick example, imagine that you have a very dovish central bank in the midst of a cutting cycle and the way that they got to a cutting cycle, of course, and got that dovish policy stance will most likely be due to a very negative economic outlook.
So imagine you are bearish on this currency based on the big picture top down analysis, but now imagine that you suddenly get a very big jump in a important forward-looking indicator, like a PMI showing that the country, the most important sector in the country let’s call it services, for example, so a very big expansionary jump in business activity.
Now, even though the market is still bearish on the currency from a longer term view, the short term data point can create some short term upside against the overall fundamental trend.
Now for most traders that will be a very stressful situation if they’re trading in line with the bigger picture fundamentals, as the market will be going against that bigger picture view, but for the opportunistic trader, they can of course look through the short term and positive catalyst and see the bigger move to the upside or downside as an opportunity to simply sell or buy from better levels. Now, something to keep in mind is that the bigger picture fundamentals can obviously change as well right?
So, imagine that we had that same scenario that we just described, where we had better than expected data, giving the currency a short term boost. Now imagine that the following week, we have another bit of an unexpected print followed by another bit of unexpected print followed by another one.
Now, all of a sudden all of those short term green shoots, in those key sectors are starting to show a more broad based positivity or a recovery in the economy, and that is likely to see further upside in terms of inflation and growth and of course should boost the labor market.
So eventually, that positive data turns into a positive trend and once the data starts trending positively, the market will start front running a more positive reaction again from the central bank towards the positive training data, which can eventually, of course, change the bigger picture macro fundamental buyers to a more neutral one and eventually to a more hawkish one.
So that is why it’s important to know when sentiment is against the fundamental view, but also what type of changes needs to occur for the overall fundamental buyers to really change.
Of course, that’s not gonna be a onetime event unless it’s a massive massive event think of something like the Brexit referendum, for example, that is a short term shift that catapulted the currency into a whole new, bearish buyers.
So there are those type of one off events that can change it, but normally it’s a steady a trending basis that we’ll need to look at to really change that fundamental bias.
But onto your question yes, you can trade against it, we use the sentiment for that and it’s also important always just to keep in mind what the bigger picture view is, in line of those short term moves.