Since currency gains and/or losses are apparent in a traders’ interpretation of the technical signals and economic data, understanding crowd psychology is also an essential tool in forex trading.
Sentimental analysis mostly derives from the focus on how markets react to risk; when traders have high-risk appetite, what follows is the desire for high yielding currencies/assets since there is a high confidence in higher returns. On the other hand, when traders do not have a high-risk appetite, what follows is usually the safe-investment in currencies such as the USD or gold, called ‘safe-havens’.
Aside from the above, knowing whether or not risk is present may also help you to figure out how traders may react to certain news reports or economic releases.
When the markets’ risk appetite is heavy, then markets may react differently in stronger ways, to upbeat reports and headlines which confirm such bias, while shrugging off down-putting data.
When risk aversion is in play, traders seem to react more negatively to tweaked data.
One method is to monitor the equity markets since stocks are generally considered to be the riskier assets, which means that opposing equities/indices may be indicative of risk appetite, while falling stocks may reflect risk aversion.
To be ahead of the markets, the trader may also look at Futures, which may be a good indication of how the stock market could perform for the current period (of 1 day).
When most futures are in the green, it may be a hint of a potential risk-taking which has been taken in the upcoming trading session; in this case, the trader can look-out for ‘risk-on’ plays, such as going long on the AUD, versus the ‘safe-haven’ USD.
When most futures are ‘in the red’, it may be an indication that the traders are loosening up on their riskier positions, even before markets open. In this scenario, the trader may favor risk-off plays such as ‘shorting’ the more highly valued New Zealand Dollar (NZD), against the less valued Japanese Yen.
Yet another indicator of such is the commitment traders’ report; this document is published by the commodity futures trading commission; in this report, the CFTC shows how other market players are trading currencies, which may give the trader a general indication of whether or not the demand for the instruments is rising (or dropping).
After monitoring how other traders are feeling about the markets, the trader can obtain a general direction of how currencies may behave, since crowds of traders are able to push such assets in a particular direction, for a certain period of time.
To ensure the benefits of this report, the trader can obtain the latest updates from the website, and search for the long & short positions for currencies, such as the USD, GBP, EUR, JPY, and other.
The most vital information to look out for is the difference in the total, long and short positions which fall under the commitments row, and this is because a positive or negative reading shows if the market players are net long, or short for the currency in question.