One big epiphany I had as a trader after losing money month after month while becoming a slave to my trading platform was that a successful trading strategy must somehow exploit the behavior of the market. I know, obvious, right? It may look obvious, but it may be a bit deeper than one typically realizes. “How do you quantify the behavior of something so complex and large as the forex market?” you may ask. Well, it gets a lot simpler when you realize that the forex market isn’t made up of lines, charts, economic data, and head and shoulder patterns—rather, it’s made up of human beings. These human beings are predisposed to act in a certain way when responding to events and fortunately we can take advantage of that to make money.
Guest post by Kris Matthews (http://tradeforexfundamentally.com)
“Don’t get sentimental on me, darling”
I can see many technical, chart-based traders already rejecting this- “are you trying to tell me you can read the emotions of the market, or something?” I hear. Well, although emotions have a lot to do with the behavior of price action, it’s more about the market’s “feeling” of the medium term outlook that determines sentiment. You see, for the time frame that most day traders and swing traders operate on, sentiment is a more dominant driving force than fundamentals or technicals. So how do we judge sentiment in forex trading?
- Price reaction to news events. If you see that price is in a nice uptrend, but then high impact news (such as employment or GDP) coming out of the currency’s country surprises the market by being more positive than expected, you would expect that uptrend to continue. (News calendars are available at such sites as Forexfactory.com and Forexpros.com) If price barely goes up after the news release or goes down, that’s an indication that there’s not enough buying pressure above and sentiment is turning negative as bulls take their profits. Vice versa for negative news in a downtrend.
- COT positioning of large traders. COT, or “commitments of traders” data is recorded and published by the US CFTC (yeah I know, they should’ve put more letters in that acronym) and shows the positioning of the major players in the market. The advantage here is that you get to see the cards of the other players you’re playing with. Large traders (a.k.a large speculators) such as hedge funds and bank prop desks take weeks to put on and take off positions, so if you see that price has been trending upward, but large traders begin taking off their positions 2-3 weeks in a row, you may be sitting on the turning point of the latest trend as sentiment is shifting. The large speculators’ positioning can be seen by the green line on Timingcharts.com charts.
Achieving forex profits in the long run
These two techniques (there are many more) will tell you the directional sentiment of the market. It’s up to you to come up with good entry and exit methods, but the most important thing in trading is getting direction right. As you begin to use these techniques, you’ll realize that they tell information about turning points even before price has made a complete turn-around and everyone else has found out about it. After everyone else has realized a new trend is beginning, it’s too late. In a market that’s so competitive (those 1 pip spreads have a price), it’s imperative that you know about the behavior of your competition and act fast when the tides of sentiment change.