In many ways, the underlying prevailing sentiment guides many, if not all, markets. Trading sentiment is an excellent indicator of where and how prices could move in the future and is, therefore, a phenomenon that all investors and traders should understand.
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Understanding Market Sentiment
Market sentiment signifies the collective thought processes and attitudes of investors in a given market. It can be positive or negative and affect the price of commodities, assets, and other investment options.
A positive market sentiment often leads to an increase in the value of the market or the price of an investment option. You will hear it referred to as bullish market sentiment and it can be a good thing if investors know about it and invest correctly.
Negative market sentiment has the opposite effect and is known as bearish market sentiment. It indicates that investors have little confidence in the market or specific investment options. Bearish market sentiment is crucial for two key reasons.
First, it tells you whether and when to exit specific markets or investments. Second, following prices and following negative sentiment can tell you when a reversal is imminent. A reversal happens when a price trend changes. For example, prices trending upwards may reverse and start trending downwards. The opposite also happens.
If negative sentiment indicates that a reversal could be imminent, it could indicate that it would be a good time to invest when the prices are that low. When the reversal happens, investors who leveraged the sentiment and consequent reversal can see their portfolios grow.
How To Leverage Market Sentiment
There are various ways to leverage market sentiments and various tools and techniques to help you do this. We will look at both below.
Technical and Fundamental Analysis
Technical analysis, including options like moving averages and chart patterns, can help you know where a market is bearing or bullish. Investors can combine technical analysis with fundamental analysis of factors like company performance, price performance, and financial traditions to know where a bearish or bullish market or option is worth investing in.
Technical and fundamental analysis are especially useful when investing in fast-moving and riskier investments like forex. Combining them with sentiment analysis can help bolster your investment decision-making and likely lead to better investment outcomes.
Leverage Short-Term Sentiment and Long-term Trends
All investors should consider the time horizons of their investments. If you are a day or short-term trader, you can leverage short-term changes in market sentiment, keeping in mind that sentiment often has a much more significant impact on short-term price movements.
Sentiment can change quickly if new information, news, or data is introduced into the market. For example, a company whose stock price was falling due to poor financial performance might suddenly change direction once positive financial data or news is released. That information could be a positive quarterly report, a merger, or the company making a substantial investment in a profitable area.
Even when leveraging short-term market sentiment trends, it is vital to stick to your underlying investment fundamentals. Long-term trends are typically not affected by market sentiment, so investors with a long investment horizon can depend on sound investment fundamentals and principles to keep their investments viable and performant.
Understand Market Psychology
Investors like Warren Buffett realized that the two primary drivers of market sentiment were greed and fear. People are likely to invest more when they are greedy and invest less when they are fearful of the market.
Additionally, greed can create asset bubbles as the demand for specific investment options grows and causes untenable price increases. Fear can cause panic selling, as most people do not want to be left holding an investment whose price is plummeting. Panic selling floods the market with specific investment options like stocks and commodities, leading to their prices falling even further.
The phenomena described above are the basis on which contrarian investing is built. Some investors have adopted a philosophy of being greedy when others are fearful, meaning they buy when supply beats demand and causes prices to plummet.
On the other hand, they are fearful when others are greedy because the untenable price increases that lead to price bubbles will eventually come down. This means some investors bought an option at very high prices and might not be able to sell it or have to sell it at a loss.
Studying market psychology to understand how greed, fear, and other emotions affect market sentiment and thus should affect your investment decisions is crucial. It can help you anticipate turning points based on sentiment shifts that either help you make a profit or avoid losses.
Conclusion
Market sentiment drives markets and prices and should drive your investment decisions too. Doing so starts with understanding market sentiment and how people think, and then understanding how to leverage it.
Author bio: Kristina Rodopska
Kristina Rodopska has been working for over 5 years as a Lean expert and engineer in the field of quality. Familiar with implementing improvements in the operations and processes within the different organizations and projects. Evaluates all continuous improvement activities and implement plans to optimize performance.
Kristina is a new and passionate writer who loves to research and give her readers exciting stories from all niches.
