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

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c05 JWBK195-Saettele May 31, 2008 11:54 Printer: Yet to come

Sentiment Indicators 83

Every market top is accompanied by a sentiment extreme, but not ev-

ery sentiment extreme leads to a market top. Market extremes, as we are

defining them here, can last for weeks. This dynamic was described by John

Maynard Keynes when he said that “The market can stay irrational longer

than you can stay solvent.” Still, exiting a few weeks early is better than

exiting after a reversal because reversals, especially in a market as highly

leveraged as the FX market, happen fast. So sit with the position until a

sentiment extreme is registered; then make a decision.

There are of course other technical tools (see Chapter 6) that can and

should be used at this point to aid in making the decision, but the point is

that now you know when a decision needs to be made. For now, I would

like to more concretely define sentiment extreme in terms of an indicator

so that we can more objectively determine when a market is at an extreme

and just as importantly, when a market is not at an extreme.

THE APPROACH

Studying commercial and speculative positioning as has been presented so

far helps in determining when a market is at a potential turning point. How-

ever, taking a closer look at the data yields better results. Most of the rest of

this chapter is dedicated to how I approach COT analysis and, more specif- ...