Sentiment is the collective mood of the market you are trading.
If the market is feeling nervous or panicked, then the sentiment is negative. If the market is feeling confident and optimistic, then the sentiment is positive.
Generally, large scale events affect the way the market is feeling.
For example, if there is a recession in the US economy, jobs and growth will suffer. This will cause a feeling of negativity in the markets.
How to judge sentiment
Sentiment is often identified by the manner in which prices are moving.
Each asset or instrument displays certain characteristics. They’re seen during times of negative and positive sentiment.
One of your roles as a trader is to identify these characteristics.
How to spot a change in sentiment
The Japanese Yen is a classic example.
When sentiment is negative, traders will flock to buy the Yen because they perceive it to be a safe haven asset.
If they are uncertain, traders will completely ignore the fundamentals of the currency in favour of safety.
As a currency trader, seeing a strong rally in Japanese Yen can be a sign that market sentiment could turn negative.
Another clue is in financial news and analysis. These outlets will generally be talking to a wide range of traders through the day.
They will pick up on common themes that seem to be running through the markets. As they report these themes, this can also alert you to the prevailing sentiment.
By watching price charts and following financial news, you will have a good idea of current market sentiment.
How can you make money from sentiment?
At first, making money from sentiment involves identifying what the sentiment is.
It is then traded in line with the prevailing trend in price that it creates. Sentiment is often traded by short term traders such as scalpers or day traders.
Sentiment can change quickly. You need to carefully watch the market to identify these changes.
How long does sentiment last?
Gauging how long sentiment lasts is one of the biggest challenges that you will face. There is no set rule or formula for this.
To become proficient, you need to watch and learn how the markets react and move during each change in sentiment.
In time you will learn market behaviour. This will allow you to make more accurate predictions on how to trade the current sentiment.
What to look out for
Sentiment can often take the price completely against the longer term fundamentals.
However, the long term fundamentals always win out in the end.
But you must be aware that market sentiment can create very large moves in the opposite direction.
As a trader you have two choices. You can either trade these moves or use them as opportunities to enter the longer term trend at a better price.
Whether you day trade or not, sentiment is a crucial piece of information that you should always be aware of.