UNDERSTANDING MARKET SENTIMENT
Market sentiment refers to the prevailing attitude of investors in a particular market.
■ Always Consider Whether Your Idea is Already Discounted by the Market
You must always consider whether the market has already discounted your trading idea. If your idea is based on news, consider that at least 90% of news is already incorporated in the prices.
Michael Marcus says that you must always ask yourself: "How many people are left to act on this particular idea? -You can evaluate that by using the classic momentum-type indicators and observing the market tone. How many days has the market been down or up in a row? What is the reading on the sentiment indexes?”
■ Make Sure There are a lot of People Who are Going to be Wrong
As mentioned before, trading is a zero-sum game where the great majority of traders lose money. Therefore, if you want to prove correct on a trade, make sure there are a lot of people who are going to be wrong.
As Bruce Kovner argues: “If you see that most of the members on your guru list are bullish at a time when the market is not moving up, and you have some fundamental reason to be bearish, you feel stronger about the short-trade. I like to know that there are a lot of people who are going to be wrong.”
Ray Dalio says: The average man tends to be much more reactive if you look at the purchases and sales that they make. When something goes up, they're more likely to buy it. They think, ah, that's a good investment. They don't know how to measure that in terms of, oh, is that a much more expensive investment that's more likely to go down?
-That's what they're attracted to. They tend to buy high and sell low, and so an average man should not be playing this game in that way”.
■ Be Contrarian to the Herd
Most of the time, you need to trade against the consensus. Ray Dalio argues: “Know how to buy when everyone else wants to sell, and how to you sell when everyone else wants to buy.
-In order to be successful, you're betting against the consensus, and you have to be right.
-The consensus is built into the price. So, because the consensus is built into the price, and assets price themselves in a way that they're all competing, and they're all of the equal value in a certain sense. There's a risk premium of equities over cash and bonds will have that over whatever, but basically, they're all priced that way.
-The biggest mistake that most people make is to judge what will be good by what has been good lately. So, if a market has gone up a lot, they think that’s a good market rather than it’s more expensive. And when it goes down a lot over the last few years, they think, ‘That’s a bad market, and I don’t want any of it'.”
Peter Lynch says: “You can beat the market by ignoring the herd.
- Dumb money is only dumb when it listens to the smart money.
- Small investors tend to be pessimistic and optimistic at precisely the wrong times.”
■ A technical pattern is more likely to confirm when it is less observed and less-discussed
The majority of traders are usually on the losing side. Therefore, when a lot of speculators publicly predict a major price breakout it will probably not happen. A technical pattern is more likely to confirm when it is less observed and less discussed by retail speculators.
Bruce Kovner argues: “The more a price pattern is observed by speculators, the more prone you are to have false signals. The more a market is the product of the non-speculative activity, the greater the significance of technical breakouts.”
■ Two Empirical Indicators that Matter
Larry Hite argues: “Although I don't really trade off indicators, there are two indicators that come to mind:
- First, if a market doesn't respond to important news in the way that it should, it is telling you something very important.
- The second item is, when a market makes a historic high, it is telling you something. No matter how many people tell you why the market shouldn't be that high, or why nothing has changed, the mere fact that the price is at a new high tells you something has changed.”
■ Don't Focus on What the Market's Going to Do, Focus on your Own Action if it Gets There
The great majority of traders try to predict where the market is going using TA and open trade positions accordingly. However, the market is uncertain and unpredictable. That means that at least 50% of the time these traders will be wrong and they will be highly exposed to unfavorable market conditions.
The most efficient tactic to deal with uncertainty is to create different scenarios about where the market is going, and decide your action in each of these scenarios:
- What will I do if the market is moving opposite to my prediction?
- Where will I close my position if the market is moving in line with my prediction?
- What will I do if the market consolidates for a long period of time?
Don’t focus on what the market's going to do; focus on what you should be doing if it gets there.
■ Have Strong Hands and be Contrarian to Weak Hands
Having strong hands is maybe the most important feature of a successful trader. You must open trade positions only for a very good reason. If there is not a critical change in the fundamental landscape, there is no point to close your positions if the market moves in the opposite direction.
William Eckhardt says: “The market behaves much like an opponent who is trying to teach you to trade poorly. Basically, I would buy when weak hands were selling and sell when weak hands were buying.”
READ MORE: 1: Market Analysis | 3: Key Trading Rules | 4: Money Management
□ MARKET SENTIMENT
(c) February 2021 for CurrenciesFx.com (c)
- Visual Capitalist (https://www.visualcapitalist.com/all-of-the-worlds-money-and-markets-in-one-visualization-2020/)
- Hedge Fund Market Wizards: How Winning Traders Win (Jack D. Schwager)
- The New Market Wizards: Conversations with America's Top Traders (Jack D. Schwager)
- Market Wizards, Updated: Interviews with Top Traders (Jack D. Schwager)