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TE08 - Basics of Market Sentiment Explained

"Market sentiment is a term given to the general health of the markets at large. It is a broad and an umbrella term used to describe the general investor feeling for the stock markets. Market sentiment is a reflect of what investors feel based on the news such as the fundamentals that are coming out. Market sentiment is an important aspect as it can prepare you as a trader in identifying what currencies or commodities to trade and which ones to stay away from. The market sentiment is largely applied to the stock markets. But you can also see this playing out in the forex or the currency markets as well. As a trader, it is in your best interest to understand the concepts of market sentiments. This article gives you a primer on what market sentiment is all about and what it infers. Based on this information, you will then able to make better judgements about your trading choices."

Market sentiment is a term that is used to describe the collective feeling of the investors at large. The term market sentiment can therefore be applied to the general markets, such as equities, bonds, currencies. They can also be applied to the securities individually.

Because market sentiment reflects the general feeling of investors, this can change depending on the markets you look at.

For example, when it comes to the currency markets, market sentiment can change depending on the currencies.

There are only two types of market sentiment.

  • Bullish market sentiment is where investors feel optimistic or positive of the asset or the market in question. In this scenario, the security or the market in question tends to appreciate or rise higher.
  • Bearish market sentiment is where investors feel pessimistic or negative of the asset or the market in question. When the market sentiment is bearish, the security or the market tends to depreciate or fall.

The two types of market sentiments are closely related to the general direction in the markets. For example, when the market sentiment is bullish, it is reflected in the price of the security which is bullish. Thus, this asset tends to appreciate sharply.

On the contrary, when the market sentiment is bearish, it is reflected in the price of the security which is generally bearish. So the bearish trend is reflected as the price of the asset starts to fall.

There are times when the investor sentiment can also be neutral. This is when investors pause to assess whether there has been a shift in the previous sentiment. Therefore, the shifts from bullish to bearish doesn’t happen at the flip of a switch.

On the contrary, the bullish market sentiment is followed by a neutral market sentiment and from here, either the bullish sentiment can prevail, or investors might feel dovish.

Why are market sentiments formed?

Market sentiments are formed because they give a way to quantify the sentiment or the direction in the markets. The market sentiment is basically a reflection of how investors perceive the fundamentals.

It is only based on the fundamentals that market sentiment is formed. Traders should not mistake that market sentiment is a result of technical analysis. On the contrary, it is the fundamentals that shapes the market sentiment.

From here on, depending on how intense the market sentiment is, technical analysis can help in identifying the levels to trade and the price direction.

How to identify market sentiment?

When the market sentiment is bullish, you can expect investors’ appetite for risk rising. This is also known as rising risk appetite, which basically reflects the bullish aspirations among investors.

During these times, the equity markets, such as stocks tend to appreciate. At the same time, lower yielding assets such as bonds tend to fall in comparison.

Similarly, you can expect bearish market sentiment. This happens when the investor risk appetite falls. It means that investors are in no mood to take on risk. During these times, investors unwind or shed their positions in risky assets and move their funds to safe haven assets.

Safe haven assets are basically the bond markets such as the U.S. treasuries. Because these instruments are backed by the full faith and credit of the government, the chance of a default is low.

But because of the lower risk in such instruments, they also yield less returns compared to the more risky stock markets.

Thus, by ascertaining what the bonds and the stock markets are doing, investors can get a feel of what the general market perception is going to be.

TE08 01 Market Sentiment

Example of the S&P500 Index with bullish and bearish market sentiment


Market sentiment in Forex

So far, we learned what is market sentiment in general and how it influences the markets at large. Digging a bit deeper, the market sentiment concept can be applied to the currency markets as well.

Not all currencies behave in the same way.

When the market sentiment is bullish, you will see that higher yielding currencies such as the Turkish lira and other exotic currencies which has a higher interest rate tends to appreciate. These currencies are also volatile, but it reflects the general mood of the investors.

The rise of the value of these currencies indicate that investors are taking on more risk because they are optimistic.

On the other hand, when the market sentiment is bearish or negative, you can expect the higher risky currencies to fall while safe haven currencies rise. Examples of safe haven currencies and commodities include the Japanese yen and the Swiss franc.

Gold is also considered a safe haven commodity which rises when the market sentiment is negative.

Read 958 times Last modified on Friday, 26 July 2019 17:36