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How to Interpret Forex Sentiment Indicators

Discussion in 'Forex Discussions' started by painofhell, Aug 23, 2015.

  1. painofhell

    painofhell Content Contributor

    Jun 24, 2015
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    Forex sentiment indicators can help your trading, especially if you’re a forex swing trader or longer-term term forex trader. Understanding how to interpret the data is key though. Forex sentiment indicators aren’t used to provide immediate buy and sell signals, the data is more of a guide to indicate when a trend is likely to continues or stall within a certain price area or time frame.

    The most powerful sentiment indicators look at how a forex pair is acting over the course of entire trends, and how the pairs sentiment compares to a historical precedent. On the Daily Forex Statistics page there is an indicator called Historical Position Ratios. This indicator shows a price graph on the right axis, and overlaying the price is a another graph (left axis) of the percentage of long positions.

    The pair and and time frame can adjusted. The 1 year time frame is the most valuable for swing and longer-term forex traders since it highlights occurrences where a particular pair is due for a major reversal.

    Figure one shows a 1 year chart of the GBP/USD versus the percentage of historical long positions.

    Figure 1. Forex Sentiment Indicators – %Long Position vs. Price – GBPUSD 1 Year (adjustable)

    Source: Daily Forex Statistics – November 9, 2013

    The chart highlights tendencies in the GBP/USD over the last year. Over this time frame, when the percentage of long positions (left axis) gets near 70% of above, a reversal higher is likely close at hand. This is not an immediate reaction though. In February the number of longs approaches 70%, but the price continues to drop until finally turning higher in March.

    This tendency repeats again near the start of July.

    There is also a tendency for the price to drop once the percentage of longs hits a very low level (this means there is a large number of short positions). When the percentage of GBPUSD long positions reaches the 30% region, a move lower is likely. On the chart, December sets this precedent. The GBPUSD tops and heads lower once there is only about 30% long positions. September and November show the same occurrence–the price appears to be topping out and the percentage of long positions indicate a significant correction lower is likely.

    Also, notice how the percentage of long positions and price move in opposite directions. As the number of longs rise the price tends to fall, and as the number of longs falls the price tends to rise. That is until the number of longs reaches an extreme, and the process starts all over again in the opposite direction.

    It’s important to note that the levels of importance will change over times, and that an extreme in the percentage of longs (high or low) doesn’t need to be present for a price reversal to occur.

    Also, not all pairs will have the same extreme percentage levels. Each pair has its own tendencies. The GBPUUSD seems to react most effectively when the number of longs reach 30% or 70%, but another pair may have slightly different extremes it reacts off of.

    Two other forex sentiment indicators on the Daily Forex Statistics shows snap-shots of what the current percentages of long and shorts are.

    Figure two shows the current levels of longs and short. A quick look at this graph lets you know if any major pairs are near potential turning points based on likely extreme long or short levels.

    Figure 2. Forex Sentiment Indicators – Long-Short Ratios

    Source: Daily Forex Statistics – November 9, 2013

    A slightly more complex forex sentiment indicator shows current open positions and open orders relative to price. This provides a quick snap short of where traders are short and long, and where orders are to enter or exit positions. Swing traders may find this information useful for “front-running” blocks of big orders. For instance, if you want to get long in an uptrend, but see there is a massive block of buy orders near the price you want, you can place your order a few pips higher to make sure you get the position.

    Figure 3. Forex Sentiment Indicators – Open Orders and Open Positions – GBPUSD (adjustable)

    Source: Daily Forex Statistics – November 9, 2013

    Forex sentiment indicators should always be used in conjunction with price analysis. Forex sentiment indicators simply confirm price analysis or may provide potential trade ideas once price confirms what the indicator is telling you.

    Final Word

    Forex sentiment indicators are available on the Daily Forex Statistics page, along with volatility, correlation and relative strength statistics.

    Use these sentiment indicators to fine tune entry and exit points, but more importantly use the historical analysis tool to see how extremes in the long-short ratio have affected the price over the longer term. This will give an ideas of when the price is likely due for a reversal. Sentiment indicators are not buy and sell signals on their own though; use other entry and exit criteria to capitalize on reversals or trend continuations which are confirmed by the forex sentiment indicators.

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