26. Understanding market sentiments
As a market participant you will have some view of the market. Similarly other participants will have their own views. Some might be thinking it is a bear market. Some others might be thinking that it is pretty bullish. These individual views transform into trades when traders trade and thus, overall market condition is a result of these mixed emotions from all the participants in the market. This is called market sentiment. It is this overall sentiment which governs the direction of market movement.
Sentiment analysis is about analysing the market sentiments. As a trader, you have to ensure you understand how the market feels at any point of time. This means we need to understand how market participants feel about a particular currency i.e. if it’s going to go high or low.
Market sentiments are formed by each individual traders view and opinion about the price movements. Sentiment data from the market are also charted and can be easily understood by the traders to get an idea of overall market conditions.
A successful trader should be able to use the market conditions to come up with his trading strategy and make profit out of it. As a trader if you feel the price of a particular currency would go up in future but the whole market thinks other way round, you can’t change the market conditions in your favour. Thus sentiment analysis is equally important as technical and fundamental analysis.
Sentiment indicators indicate the amount of position taken by traders for a currency pair in a market. By using this traders can determine the percentage of traders who are taking long or short positions and decide upon the strategy he wishes to follow. Sentiment indicators become really useful when the position taken by the traders in a particular currency pair becomes maximum. Sentiment indicators come in various forms and are very useful.
Sentiment analysis might not be enough to decide on taking the entry and exit positions but yes when it is combined with technical and fundamental analysis it is really helpful in determining if you would like to continue with the flow or not. Now, how do you measure the volume of currency traded in the forex market. You need the volume to determine the market sentiments. It is pretty easy in case of other stocks because there is a centralized market place. Forex on the other hand is mostly done over the counter and hence it is not as easy to determine the volume of trades.
This is where Commitment Of Traders (COT) comes into picture. The Commodity Futures Trading Commission (CFTC) publishes the Commitment of Traders Report (COT) every Friday, around 2:30 pm EST. This report details the current condition of the market operations including the positions. Thus Forex Traders depend on this report understand market sentiments. It is also easy to determine how speculators and retail traders have taken their positions. Hence you get to see behaviours from all the market players. Basically COT reports positions held by three different types of traders:
- Commercial Traders – Retail traders or hedgers
Hedgers are traders who want to protect themselves against unexpected price movements. o Non Commercial Traders – Large Speculators
Speculators are those who make money out of speculation. They don’t want to own any asset instead just make money by predicting future price movements.
- Non Reportable traders – Small speculators
Small speculator comprises of hedge funds and individual traders who own smaller retailer accounts.
Here is a list of some of the items you will see in a COT report:
These are entities which represent big businesses who use futures contracts mainly for hedging purposes.
Individual traders, hedge funds or large institutions who are basically speculators and make use of futures market for speculative purposes.
Number of long contracts as reported to CFTC.
Number of short contracts as reported to CFTC.
- Open Interest
Number of open contracts that are yet to be delivered or exercised.
- Number of traders
Total number of traders who are required to report position to CFTC.
- Reportable Positions
The number of options and futures positions that are required to be reported according to CFTC regulations.
- Non Reportable Positions
Long and short open positions that don’t meet reportable requirements set by CFTC.
To summarize, the weekly COT report submitted by CFTC details both commercial and noncommercial positions. This report thus details the commitments of traders. It provides a breakdown of the positions held by three types of traders: Commercial Traders (Hedgers), Non Commercial Traders (Large Speculators) and Non Reportable traders (Small Speculators).