Market Sentiment and Positioning
Although asset prices are mainly dependent on technical and fundamental factors, they can also be affected by market sentiment. Emotions generally modify markets, and these feelings can be reflected in the price.
For example, the market reacted nervously to the 2016 inauguration of Donald Trump in the US. While most polls predicted a Hillary Clinton victory, markets went into a state of shock when Trump was the winner. The reaction led to a general sell-off of the dollar and US indices, but quickly as nerves calmed down, traders began buying the greenback and stocks. Why? Because Trump’s policy seemed positive for the American economy.
However, the first reaction primarily propelled from sentiment and not solid fundamentals. For this reason, it is essential to take into account the feeling of the market while we operate and to know what indicators can help us in this task.
What exactly is market sentiment?
Market sentiment could be defined as the consensus of investors’ attitude towards a particular asset or the market as a whole. This sensation is revealed through the price movement. It is important to remember that sentiment is not always fundamentally based. That means that investors could have a particular vision based on what they feel rather than what they see.
Sentiment can be classified as bullish, bearish, or neutral. When bearish sentiment prevails, assets fall. On the other hand, a bullish view is positive and supports the purchase of different assets.
How to measure it?
This is the tricky part. How do you measure something that is directly connected to human psychology? In financial markets, everyone has their own opinion, and everyone is looking for something to build on. However, several survey-based indicators are performed by market participants.
Positioning – another approach to the market
Positioning can be another indicator of market sentiment. While sentiment studies show market predisposition, positioning does the same but taking open positions as a reference. In this way, the bullish or bearish bias occurs in buying or selling positions in a specific asset.
For example, if a report shows a significant increase in long positions in the US dollar, it means that the currency’s market outlook is bullish.
The most popular and important reports are those offered by CFCT. They provide a report of open interest in the markets on 20 or more investors who hold positions in the market equal to or greater than the reference value established by the CFTC.
In essence, they show the net position of long or short positions available for each available futures contract, distinguishing between different investors. The most important impact occurred from traders who seek mere speculation since they are the ones that alter the price the most.
How to use it in practice
Now we know what market sentiment is. However, it remains to be said how to use this information in practice. As we know, if the market is bullish, the indices or currencies will likely skyrocket. In this situation, the positioning should show a large net long position.
This means that if something unexpected happened, investors would have to quickly close all their positions, leading to a rapid fall in price. As we can see, a situation of this type occurred in 2015 with the US Dollar.
The market was bought for the dollar, and the net buying position was at maximum. The FED, however, decided in its meeting not to send an aggressive message which forced traders to close their buy positions in the dollar. This resulted in a dramatic drop sending the EUR/USD from 1.05 to 1.10 in less than 3 hours.
Market sentiment is a useful tool for analyzing the market. However, we must remember one thing, sentiment and positioning are changeable indicators. Therefore, it must be an additional tool and not used as a sole reference.
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