While all forex traders bring their own strategies, preferences, and emotions to the trading market, the collective trends behind those sentiments can reveal a lot about how overall trader sentiments may shape price movements and forex market activity.
The concept of market sentiment is applicable to any financial trading market, including forex, and these sentiments can play a powerful role in predicting the kinds of price movements and other market effects that may develop in the near future.
Fortunately, traders don’t have to make guesses about these sentiments on their own. Through the use of forex market sentiment indicators, any trader can evaluate how macro market sentiments may be reflecting overall ideas, hesitations, and other underlying factors that are pushing the majority of traders in a single direction regarding their trading strategy.
With accurate market sentiment forecasts, you can better predict how forex prices may change in the near future based on how the majority of traders are likely to react to existing or upcoming market conditions. To help you identify and understand these sentiments, here are three indicators to use in your analysis.
1. CBOE Volatility Index (VIX)
The CBOE Volatility Index is a measure of 30-day volatility for a representative range of options from the S&P 500 index. Higher volatility can be a sign of market pessimism or uncertainty about the long-term strength of those assets.
“The VIX,” as it’s known conversationally among many traders, is most valuable to forex traders as a tool for interpreting market sentiments for currencies and currency pairs strongly correlated with the S&P 500.
The U.S. dollar, for example, has historically been strongly correlated with the CBOE Volatility Index, which means that volatility in the VIX can reflect expected volatility in the strength of the U.S. dollar. USD/EUR is a currency pair that is often affected by the sentiments represented by the VIX, which can help traders time their entry and exit points.
Because it represents the number of put options placed by investors to protect their assets against a swift decline in prices, the VIX is also known as “the fear index” because a high number of put options can cause this indicator to spike, alerting traders that the market is growing wary of potential volatility.
2. NASDAQ Composite Index (VXN)
Similar to the VIX, the CBOE’s NASDAQ Volatility Index (VXN) is a real-time index that reflects the market’s overall expectations for price volatility among NASDAQ 100 stocks. This market sentiment indicator is also focused on the next 30 days from whenever its data is referenced, giving forex traders a window into expectations around economic developments that may affect NASDAQ market prices.
As a tech-heavy index, NASDAQ and VXN are most relevant to forex currencies and pairs with strong economic ties to tech corporations. This is true for both the United States and Japan, which is why USD/JPY tends to trade in the same direction as VXN sentiments. When sentiments are upbeat, the pair’s price is likely to trend upward. When sentiments take a turn toward pessimism, expect prices to follow suit.
3. NYSE 200-Day Moving Average
The NYSE 200-day moving average shows traders how many stocks are trading above their long-term moving average. In other words, it can be a measure of bullish market sentiment and a potential tool to determine when market sentiments have gone too far and are likely to face a correction.
This sentiment indicator measures trader sentiments as a percentage of stocks being traded above their 200-day moving average. While a higher number typically indicates bullish sentiments and favorable price growth in the near future, traders can get too much of a good thing. When more than 80 percent of stocks are going above their moving average, it can be a strong sign of overbought conditions and may predict a price drop.
As a New York-based exchange, this sentiment indicator is most reflective of trends affecting the U.S. dollar. However, other forex markets may show a strong correlation to this metric, making it valuable as a predictor of market movement among those currencies.
While this list of sentiment indicators is far from complete, it does feature some of the most commonly used and reputable indicators to help you get your feet wet and better understand the use of sentiment indicators in your forex trading strategy. As you become more comfortable with these indicators, you’ll be able to identify the best volatility measures that align with your particular area of forex focus.
Try your hand at using market sentiment indicators today by opening a free Valutrades demo account.
The information provided herein is for general informational and educational purposes only. It is not intended and should not be construed to constitute advice. If such information is acted upon by you then this should be solely at your discretion and Valutrades will not be held accountable in any way.