Following the general public sentiment of a market is one of the newer ways for investors to gain an edge. Fortunately, those who prefer to buy and sell foreign currency pairs, also known as forex trading, have a number of excellent options to select from. One reason for the good news is that the currency markets are the largest and most widely traded in existence.
Every day, unimaginable quantities of money change hands across the globe. As newcomers and institutions trade side by side, how can amateur forex practitioners glean worthwhile data from the same sentiment indicators used by governments, international banks, and wealthy individuals? The essential part of the equation for part-time and casual FX traders is learning how the indicators work and understanding what each one measures. Here are the central pieces of the puzzle.
What Gets Measured?
Gauging public sentiment is an effort that attempts to put emotional, qualitative data into a quantitative box. It’s not always perfect and can give some false signals, but these kinds of indicators do serve an important purpose. Investors can gain insight into how the majority of other traders feel about a given currency or the market in general. Most indicator-based indices attempt to quantify the number of buyers vs. the number of sellers in a broad sense. There are several variations on that theme, but all the popular sentiment indicators fall into that category. The following details explain how a few of the main sentiment indicators work.
Anyone who reads a beginner’s guide to forex will inevitably stumble across the topic of sentiment indicators. It’s even possible for individuals to leverage the data within the indicators to decide on entry, exit, take-profit, and stop-loss prices on particular trades. Following an indicator that displays open interest can tell forex traders a lot.
As futures prices for a particular currency pair rise, if the number of holders who keep their positions open also rises, that usually means there is a high degree of confidence that the pair will continue to appreciate in value. Those who subscribe to this philosophy might decide to exit a position if the associated futures values rise but the number of holders who maintain an open position falls. That’s because they’re assuming that other holders are jumping ship and exiting their positions as the rising values become, at least theoretically, more difficult to sustain.
COT (Commitment of Traders)
The COT is a widelyfollowed sentiment indicator that is simple in its construction and quite easy for newcomers to understand. It measures the number of traders who are either long or short on a given currency pair at a particular point in time. Unlike Open Interest, which is not a real-time measurement, COT represents non-delayed statistics. While the raw information might not serve a purpose for casual traders and investors, the thing to watch for in a COT sheet is the crossover point. That occurs when the number of longs and shorts switches places. If there are more longs than shorts for EUR/USD, then the strength of the pair is relatively positive, depending on a number of other factors.
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