Sentiment in the Forex Market: Indicators and Strategies to Profit from Crowd Behavior and Market Extremes

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CHAPTER 1

The Argument

for a

Sentiment-Based

Approach

A

t its core, sentiment is a general thought, feeling, or sense. In free

markets, sentiment refers to the feelings and emotions of market

participants. All of the participants’ feelings toward a specific mar-

ket result in a dominant psychology that is either optimistic or pessimistic.

Every change in price results from a change in the balance between opti-

mism and pessimism. Price itself is a result of where collective psychology

lies in the never-ending oscillation between optimism and pessimism. As

oscillation suggests, the psychological state of a market experiences peaks

(optimistic extreme) and troughs (pessimistic extreme). These sentiment

extremes are what affect market tops and bottoms.

In the 1932 edition of Charles Mackay’s classic Extraordinary Popu-

lar Delusions and the Madness of Crowds, Bernard Baruch wrote in the

foreword that “all economic movements, by their very nature, are moti-

vated by crowd psychology.” Baruch went on to write in the same fore-

word that “without due recognition of crowd-thinking (which often seems

crowd-madness) our theories of economics leave much to be desired.”

1

It seems that so many, if not most, of the members of the financial com-

munity seem to forget these basic truths. Analysts, traders, and financial

media