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

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c06 JWBK195-Saettele June 5, 2008 19:35 Printer: Yet to come

146 SENTIMENT IN THE FOREX MARKET

Consecutive Up and Down Periods

Much like a rate of change extreme announces the start of a new trend, a

consecutive number of closes in the same direction often announces that

the trend is reaching a point of exhaustion. A currency pair that closes up

or down for x number of periods in a row indicates near complete agree-

ment among market participants as to the direction of the market. The mar-

ket could be crowded with too many bulls (in the case of consecutive up

periods) or too many bears (in the case of consecutive down periods). An

analogy that accurately describes the state of the market during this time

is that of a boat with too many people sitting on one side. What happens?

The boat tips over. The same thing happens in financial markets and in the

FX market in particular.

Fear is the dominant emotion in the FX market. Currencies are traded

in pairs. Therefore, if a trader is long one currency, then he or she is also

short a different currency. What I am getting at is that a currency is of-

ten bought since it is viewed as being the lesser of two evils. For exam-

ple, the EURUSD rate has not skyrocketed to record levels recently (this

is late 2007) based on an overly optimistic outlook for the Eurozone but

rather because of fear of the U.S. dollar. Fear is an extremely ...