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

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The Problem with Fundamental Analysis 11

Scientific research has found that the limbic system, the emotional part

of the brain, works faster than the neocortex. This describes why “feelings

of certainty can be so overwhelming that they stand fast in the face of logic

and contradiction. They can attach themselves to a political doctrine, a so-

cial plan, the verity of religion, the surety of winning on the next spin of

the roulette wheel, the presumed path of a financial market or any other

idea.”

3

In other words, emotion trumps rational thought. Financial specu-

lation induces herding behavior, which is controlled by the limbic system.

“As a primitive tool of survival, emotional impulses from the limbic system

impel a desire among individuals to seek signals from others in matters of

knowledge and behavior and therefore to align their feelings and convic-

tions with those of the group.”

4

Most market participants’ ideas stem from

other market participants, which leads to the creation of a crowd. “They

are driven to follow the herd because they do not have firsthand knowl-

edge adequate to form an independent conviction, which makes them seek

wisdom in numbers. The unconscious says, You have too little basis upon

which to exercise reason; your only alternative is to assume that the herd

knows where it’s going.” ...