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Market sentiment: indicators and application and how to use them

Market sentiment is an indicator that shows the current ratio of buyers and sellers in the market. Market sentiment takes into account the number and volume of orders in the Depth of Market at the present moment. This is an auxiliary tool that allows you to gauge the trend direction and anticipate a potential pivot point.

The article covers the following subjects:

Read on, and you will learn in detail what is the Forex market sentiment and how you can define the market sentiment online.

What is market sentiment?

Each trader has their own opinion about where the price will go. Actually, the price, at each moment, can go in one of three directions: up, down, sideways. The volume of the transaction depends on how confident the trader is in the decision. The more confidence, the more volume.

Market sentiment is the ratio of trade volumes between buyers and sellers.

If the total volume of buy trades prevails, the market is bullish. If the volume of sell trades is greater, the market sentiment is bearish.

The market sentiment reflects the distribution of buy and sell trade volumes in the total pool of orders. Based on this indicator, we can see how many traders currently believe that the market will go up or down.

There are many techniques for identifying the market sentiment in Forex trading. Among them are analyst polls, collection of statistics from exchanges, etc. The easiest way to determine market sentiment is to analyze orders in the Depth of Market of an individual broker.

Why do you need a market sentiment indicator?

  • To visually assess the general state of the foreign exchange market. It allows monitoring the direction of the price movement of multiple trading assets.

  • To estimate the trend strength of a particular pair. A 50/50 ratio could mean trading flat or a potential trend reversal. A 90/10 ratio means a strong trend or that a significant capital entered the market.

  • To confirm your trading decision to buy or sell.

  • To develop an independent trading system. You can use it in trading correlated pairs, in counter-trend trading strategy, or cross rate trading, and so on.

One of the market sentiment indicator’s flaws is that it is affected by market makers. 

How does market sentiment work?

Let me give you a simple example.

Suppose five hundred traders entered the market at the moment. They believe that the HK50 index will go down in value and enter short trades of 100 USD each. Next, there appears one more trader who believes the price will grow. The rich buyer enters a trade of 150,000 USD in the opposite direction, i.e., opens a long position.

The aggregate volume of sellers is 50,000 USD, and the total volume of buyers is 150,000 USD. The buying pressure results from one large trade.

The indicator calculates the total volume of sales compared to purchases:

$volume_buy / ($volume_buy + $volume_sell) * 100 = current market sentiment

 $150000 / ($150000 + $50000) * 100 = 75%

This difference between the volumes of buy and sell trades affected the market sentiment, suggesting the market is bullish. Likewise, in our example, the market sentiment indicates that 75% of the market supports buying. However, the majority of traders bet on selling.

Therefore, the more traders there are in the market, the more accurate (relevant) is the indicator value. But the traders with large volumes could also be more informed. Also, the market sentiment indicator cannot be correlated with the timeframe. 

It is impossible to define whether the sentiment refers to a short- or long-term trend. Therefore, market sentiment is only an auxiliary tool, complementing the primary strategy.

How to find market sentiment?

You can see the market sentiment on the websites of independent analytical resources: finviz.com/forex.ashx or barchart.com/forex; there are some more of such platforms. However, it is difficult to state for sure how often the information on such websites updates and where it comes from. That is why I suggest a simpler way to study the market situation. You can use the online forex market sentiment indicator in the LiteForex client profile

You can find the market sentiment in the following way:

1. Open the main page of the client profile. The current market sentiment is indicated on the currency pair tab (red boxes in the screenshot). Red means the bearish sentiment, green – bullish.

If you do not see the market sentiment, you need to enable the indicator in the top right corner.

Note that the second arrow points to the option to enter a trade in one click right away on the profile’s main page. For example, the EURUSD market sentiment is 71.9% bearish, and you can enter a sell trade by clicking on the Sell button below. This function allows you to manage multiple transactions for several currency pairs. Likewise, you can monitor the trader sentiment in stock market.

2. Click on the currency pair tab and enter the Analytics menu. Here, the market sentiment is displayed as a two-color band showing the bullish and the bearish sentiment percentage.

It is convenient to analyze the market sentiment in the Analytics tab. There is also information on other technical indicators (which you can also use in your technical analysis) with the recommendation to Buy or Sell. You can also find there the news and fundamental factors explaining the prediction for the intraday price trend.

The advantages of market sentiment indicator

Listed below are some of the benefits I noted when using the market sentiment indicator in the LiteForex trading terminal:

  • You can access it any time. You don’t have to enter other websites. The indicator is conveniently placed next to the trading instrument. You can monitor the market sentiment for multiple currency pairs or stocks on the profile’s main page. I showed it in the above screenshot. It is convenient to spot correlations.

  • It is updated every hour. The sentiment analysis is displayed based on open positions of the LiteForex traders, therefore the values are always relevant.

How to trade market sentiment?

There is no single instruction on developing a trading strategy based on the market sentiment; everything is individual. The most straightforward trading approach is to enter a trade in the direction suggested by the majority. 

For example, the ratio of volumes of trades entered by buyers and sellers is 80/20. It means that most traders bet on price growth. So, you enter a long position (buy). However, you should consider that you can open a position at the trend high and face a loss. 

Another market sentiment strategy suggests entering trades at the trend reversal. For example, the percentage of buy volumes has been rising for several hours (65/45, 70/30, 90/10). At some point, the buying pressure stops growing and starts moving in the opposite direction, to the 50/50 ratio. 

It means that the uptrend is exhausting, and when the market sentiment goes below 50/50, the trend will reverse down. Before opening a position, confirm the trading idea by oscillators (analyze the overbought and oversold zones) or other technical tools. 

Although market sentiment accurately identifies the current market situation, you should be very careful when trading the sentiment.

Market sentiment in Forex trading

I want to write a few tips on using the market sentiment indicator in Forex trading.

  • Take into account the market sentiment only in the short term. Check the sentiment every hour when it updates. The sentiment indicator considers the volumes of open positions to buy or sell at the current moment. However, it doesn’t indicate how long these positions will be held open. For example, you see a 70/30 ratio in favor of long positions. An hour later, the ratio changes in the opposite direction. It could occur because the market makers with large trade volumes exited long positions at the key resistance level.

  • Apply the sentiment analysis together with other indicators, for example, the ones presented in the Analytics tab. There could be a situation opposite to the one described above. Indicators recommend you to buy, but 72% of traders hold shorts.

The reason is that the indicators signal the local market situation at the current time, while most traders expect a long-term downtrend. 

It is clear from the above figure that the current (most recent) hourly candlestick is rising, but the primary trend is down.

  • Trust mostly the sentiment data for the most liquid currency pairs featuring the most significant transaction volumes. The more there are Forex traders and the more trades they enter, the more accurate are the indicator data. For exotic currencies with relatively small trade volumes and few transactions, a market maker can dramatically affect the values just in a minute.

Market sentiment indicators for МТ4

The LiteForex Client Profile is convenient for traders because of its unique technical indicators and extended functions. But if you are used to working with MetaTrader 4, there are good sentiment indicators as well.

One of the mt4 market sentiment indicators that I use is called the Sentiment indicator.

The indicator estimates the share of bulls and bears in the market using the Depth of Market. One of the market sentiment chart versions, located under the price chart, moves relative to the zero level. The farther the indicator is from the center, the more buyers (the indicator is above zero) or sellers (below zero) are in the market.

You can download the template of this market sentiment indicator version here. There is another version, a histogram showing four states of the market: rising or falling bullish market sentiment and rising or falling bearish sentiment. This version template is here.

Sentiment analysis for stock market

In the stock market, the sentiment is determined by investors’ attitude towards an individual stock and the market as a whole. The indicator analyzes the sentiment of most traders. If the sentiment is bullish, the ongoing trend is likely to be up. If it is bearish, there should be a downtrend at the moment.

Important! Market sentiment indicators do not guarantee that the indicated trend will continue. It doesn’t also show the trend strength, as the majority opinion may change at any minute. The key influencing factor can be a force majeure, the publication of financial statements that do not correspond to traders’ and analysts’ forecasts. 

Other important factors include regulators’ actions or media persons’ opinions, a change in correlated instruments’ price.

Example:

In 2020, Tesla stock appreciated by 700%. 2021 also started with an optimistic outlook. Most investors were bullish. Until February 20, the company’s stock was up compared to 01.01.2021. 

Next, Tesla invested $1.5 billion in the BTC.

The cryptocurrency volatility is very high; the news about the investment pushed the BTC up, followed by a drawdown. Along with the BTC price drop by 12% over one day, the Tesla stock was 8.6% down. It was the worst drop since September 2020; the majority sentiment instantly changed to the opposite.

How to measure market sentiment in stock market?

1. Study the information on the analytical platforms

They aggregate information from exchanges, so their data can be called objective to some extent. However, the exact principle of calculation is unknown.

The most popular analytical platforms include:

  • Finviz is a website providing analytical and screening tools for the US stock market. It covers over 7,500 stocks, futures, and other derivatives.

The platform provides general market sentiment, identified according to several criteria. It can analyze the number of shares that have risen and fallen in price. The screener also examines the number of stocks that have updated their highs and lows. Or it can consider the location of the share price relative to the moving averages with a period of 50 and 200. If the data are controversial, and there is no predominance in put call ratio by at least 60%, you should not open positions.

  • AAII, American Association of Individual Investors. The AAII investor sentiment survey held every week provides the market sentiment percentage. And also, information is provided only for the overall market; there is no information in the context of individual shares.

2. Analyze the market sentiment using indicators

You can use the following indicators for technical analysis of market sentiment.

Moving Averages

There are two moving averages with periods of 50 and 200 on the daily chart of the FB stock. If the fast MA (50) crosses the slow MA (200) upwards, the market sentiment is bullish. It means the trend is likely to be upward.

The yellow MA (50) crosses the blue MA (200), confirming the uptrend. Moving Averages are suitable for long-term strategies and can be used for preliminary analysis. The drawback is that the indicator is lagging.

Volume Indicator

It is displayed as a histogram with red and green columns. The green column means that the current candlestick’s trading volume is more significant than the previous one. Red means that the trade volume is lower. Trading volume indicates investors’ interest in the current price trend, confirming the price movement up or down.

The trade volumes begin to grow when there starts a downtrend. It means that more and more investors are getting confident in the trend continuation, the volumes of short positions are increasing. If the columns are getting smaller, the volumes of short trades are lowering, the downtrend is exhausting and could reverse soon.

Advance Decline-Ratio

Advance Decline-Ratio indicates the difference between the number of rising and falling stocks. Its formula is (Rising Stocks – Falling Stocks) / the Total number of Stocks. A value of more than 70% in one direction or another is regarded as the prevailing sentiment of bulls or bears. It confirms the trend strength.

Sentiment

There is a brief description and the template of the Sentiment indicator above.

3. Macroeconomic indicators

These are fundamental indicators showing the sentiment of investors, traders, households concerning economic development. It can indirectly serve to assess the future stock indexes price movements in the long term.

Index of Leading Indicators

The Index of Leading Indicators, also known as the Leading Economic Index (LEI), is based on ten economic indicators. It considers inflation, unemployment, new orders in the consumer sector, and so on. A high index value indicates economic growth, and so the stock market prices should rise as well. An abnormally high value indicates possible overheating of the economy and subsequent stagnation. The economy’s state affects the financial market.

Consumer sentiment indexes

Most of the sentiment indexes are based on regular household surveys. You can also study the consumer confidence index. It is difficult to assess their objectivity, but consumer sentiment can be a useful supplementary tool.

Market Sentiment FAQ

1. You can use the sentiment indicator on the broker website. For example, on the LiteForex website, you can find the market sentiment on the trading platform. Open the page with the list of trading instruments. You can study the market sentiment of all currency pairs, stocks, indexes, cryptocurrency, oil, precious metals.

Or, you can enter the Analytics tab for each asset. If the dominance of buyers or sellers is more than 60%, there could be a strong trend.

2. You can use two Moving Averages, a fast and a slow one. If the fast MA crosses the slow one from the bottom up, it means the bullish sentiment prevails. Therefore, the trend should be up. The closer is the MA crossing angle to 90 degrees, the stronger the trend is and the faster the price is growing.

3. You can use volume indicators. If the chart shows a trend and the trade volume is growing, it means that traders are confident in the trend continuation.

There are two ways to affect the market sentiment:

1. One can increase the volume of positions to buy or sell. For example, there is a parity in the market. The number of orders with small buy and sell volumes is approximately equal, and the price is trading flat. To change the market sentiment, you need to open a position of a large volume that can satisfy a significant part of the current opposite orders.

Accordingly, there will be an imbalance. In practice, this situation occurs when a market maker, an institutional investor with large capital, enters a trade during a sideways trend.

2. There could increase the number of traders going to buy or sell. The more there are individual buyers, for example, the greater will be the shift in the market sentiment towards the price rise. In real trading, such a situation could occur due to a fundamental factor. For example, after the news that Elon Musk’s Tesla invested in bitcoin, there increased the number of individual investors willing to invest in cryptocurrency.

Sentiment analysis suggests measuring the sentiment index stock market and investors’ attitude to stocks, bonds, futures, and other stock exchange assets. The sentiment analysis finds out the ratio of buyers and sellers in the market to determine if the market sentiment is bullish or bearish. There are several ways to learn the market sentiment:

Sentiment analysis suggests measuring the sentiment index stock market and investors’ attitude to stocks, bonds, futures, and other stock exchange assets. The sentiment analysis finds out the ratio of buyers and sellers in the market to determine if the market sentiment is bullish or bearish. There are several ways to learn the market sentiment:

• Analyze the data of the sentiment indicators provided on analytical portals — for example, Finviz, AAII, Barchart.

• Analyze the market sentiment indicator data on the websites of individual brokers.

• Analyze composite indexes, such as leading indicators index, consumer sentiment index.

• Use the technical analysis indicators, such as moving averages and volume indicators. Analyze the Depth of Market.

Summary of the use of market sentiment in trading

Market sentiment is an auxiliary indicator that allows you to confirm your trading decisions or develop a trading system. You should not rely on the market sentiment alone when deciding to buy or sell. It is a supplementary tool to analyze the market situation and make sure if your investment decisions are profitable. 

You can see the market sentiment of any trading asset today in the LiteForex client profile without registration. You just need to click on the required trading asset and enter the Info on the instrument section. If you have any questions, write in the comments, I will do my best to answer!


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The content of this article reflects the author’s opinion and does not necessarily reflect the official position of LiteForex. The material published on this page is provided for informational purposes only and should not be considered as the provision of investment advice for the purposes of Directive 2004/39/EC.

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