How do you view the forex market ? - Required Mindset Every Trader Should Own !
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Do you see it as a big mechanical matrix which is devoid of emotions? Or do you think of it in mathematical and probability terms? Perhaps, you may even view it as just a vast network of computers which are designed to cheat the trader sitting in front of his or her computer and trading electronically.
Most traders I know have a love-hate relationship with the forex market, thinking that the market is, in turn, either against them or for them. To me, the forex market is nothing more than the compressed display of emotions.
at any one time emanating from currency speculators around the world. It is similar to a big living organism, like a human being, which is made up of numerous cells, with each cell carrying out its own function and interacting with other cells of the body, working to keep the body alive with round-the-clock chemical and biological processes.
The forex market is alive as a macro living organism, which comprises a vast number of market participants acting out their perceptions and emotions, thus driving the blood around the invisible entity. The participation of each player, whether the player is an institutional dealer or an independent trader, is akin to the individual functioning of a cell, which collectively will constitute the whole organism – the forex market in this case. Knowing what the market thinks and how it thinks is crucial to trading success because, ultimately, the trader is dealing with other traders out there, and needs to know what they are thinking. Even if you see the market as an enemy, what could be better than knowing the weak points and being able to read the mind of your adversary?
In this post, I shall focus on how you can better understand the market, and use that knowledge as one of your trading weapons.
In the process of making educated trading decisions, traders have to weigh a multitude of factors which could influence the bias of a currency, before making up their minds about the current and future state of certain currencies. One thing to note is that market sentiment is not logical; it is primarily based on traders’ emotions, which is really one of the greatest, if not the greatest, factor in the determination of a currency exchange rate.
If the majority of the market wants to sell that currency, the market sentiment is deemed to be bearish; if the majority wants to buy that currency, the market sentiment is bullish; and when most market participants are unsure of what to do at the moment, the sentiment ends up being mixed. Since the US dollar is the currency
on the opposite side of 80% of all foreign exchange transactions, most traders will be concerned with what the market thinks about the US dollar. Currency prices simply embody the market’s perceptions of reality and the sum total of traders’ emotions. Market sentiment acts like a fickle lover, capable of changing its mind based on certain incoming new information which can upset the existing sentiment. One moment everyone could be buying the US dollar in anticipation of a stronger dollar; the next second they could all be dumping it as they fear the dollar would start to weaken due to the impact of some new piece of information, which is almost always some fundamental news.
Understanding the current market sentiment and exploiting it appropriately with the other strategies discussed in this book can help maximise your trading profits,because if you can guess what the other market players are thinking about, and understand why the market is doing what it is doing, you will be in a better position to plan your entry and exit points and timing.
WHAT FACTORS INFLUENCE MARKET SENTIMENT?
Controlling inflation
Central banks are responsible for ensuring price stability in their own country, and one of the ways they employ to fight inflationary pressures is through the setting of interest rates. If inflation risks are seen to be edging upward in, say, the US, the Fed would raise the federal funds rate, which is the rate at which banks charge each other for overnight loans.
When the overnight rate is changed, retail banks will change their prime lending rates accordingly, hence affecting businesses and individuals. An increase in interest rates is an attempt to make money more expensive to borrow so that there will be a gradual decrease in demand for that currency, thus slowing down an overheated economy. The opposite scenario is true too: when a country faces deflation, or even decreased inflation, which is often the result of decreased spending, whether by the government, consumers or investors, it prompts the central bank to lower interest rates so as to stimulate spending.Interest rates and currencies
The most important way in which interest rates can influence currency prices is through the widespread practice of the carry trade. A carry trade involves the borrowing and subsequent selling of a certain currency with a relatively low interest rate, then using the funds to buy a currency which gives a higher interest rate, in an attempt to gain the difference between these two rates – which is known as the interest rate differential. The trader is paid interest on the currency he or she is long in, and must pay interest on the currency he or she is shorting. This difference is the cost of carry. Therefore, a currency with a higher interest rate tends to be highly sought after by investors looking for a higher return on their investments.
Rising interest rates in a country tends to strengthen that country’s currency relative to other currencies as investors exchange other currencies to buy the currency of that country when they transfer their assets into the country with the higher interest rates. The increased demand for that particular currency will thus push up the currency price against other currencies.
Most traders I know have a love-hate relationship with the forex market, thinking that the market is, in turn, either against them or for them. To me, the forex market is nothing more than the compressed display of emotions.
at any one time emanating from currency speculators around the world. It is similar to a big living organism, like a human being, which is made up of numerous cells, with each cell carrying out its own function and interacting with other cells of the body, working to keep the body alive with round-the-clock chemical and biological processes.
The forex market is alive as a macro living organism, which comprises a vast number of market participants acting out their perceptions and emotions, thus driving the blood around the invisible entity. The participation of each player, whether the player is an institutional dealer or an independent trader, is akin to the individual functioning of a cell, which collectively will constitute the whole organism – the forex market in this case. Knowing what the market thinks and how it thinks is crucial to trading success because, ultimately, the trader is dealing with other traders out there, and needs to know what they are thinking. Even if you see the market as an enemy, what could be better than knowing the weak points and being able to read the mind of your adversary?
In this post, I shall focus on how you can better understand the market, and use that knowledge as one of your trading weapons.
WHAT IS MARKET SENTIMENT?
Market sentiment is simply what the majority of the market is perceived to be thinking or feeling about the market – it is the most important factor that drives the currency market. This is so because traders tend to act based on what they feel and think of certain currencies, regarding their strength or weakness relative to other currencies. I will assume that when you trade currencies, you don’t blindfold yourself to simply pick any pair to buy or sell, leaving it to randomness to determine your profit/loss statement at the end of the day or month. Market sentiment sums up the overall dominating emotion of the majority of the market participants, and explains the current actions of the market, as well as the future course of actions of the market. The trend adopted by the forex market is actually a reflection of the current market sentiment, which in turn guides the trading decisions of other traders, whether they should long or short a currency pair.
In the process of making educated trading decisions, traders have to weigh a multitude of factors which could influence the bias of a currency, before making up their minds about the current and future state of certain currencies. One thing to note is that market sentiment is not logical; it is primarily based on traders’ emotions, which is really one of the greatest, if not the greatest, factor in the determination of a currency exchange rate.
There are three main types of sentiment when it comes to forming opinions in the forex market:
- 1. bullish,
- 2. bearish or
- 3. just plain confused.
If the majority of the market wants to sell that currency, the market sentiment is deemed to be bearish; if the majority wants to buy that currency, the market sentiment is bullish; and when most market participants are unsure of what to do at the moment, the sentiment ends up being mixed. Since the US dollar is the currency
on the opposite side of 80% of all foreign exchange transactions, most traders will be concerned with what the market thinks about the US dollar. Currency prices simply embody the market’s perceptions of reality and the sum total of traders’ emotions. Market sentiment acts like a fickle lover, capable of changing its mind based on certain incoming new information which can upset the existing sentiment. One moment everyone could be buying the US dollar in anticipation of a stronger dollar; the next second they could all be dumping it as they fear the dollar would start to weaken due to the impact of some new piece of information, which is almost always some fundamental news.
Understanding the current market sentiment and exploiting it appropriately with the other strategies discussed in this book can help maximise your trading profits,because if you can guess what the other market players are thinking about, and understand why the market is doing what it is doing, you will be in a better position to plan your entry and exit points and timing.
WHAT FACTORS INFLUENCE MARKET SENTIMENT?
Interest ratesTrends in interest rates are one of the most significant factors influencing market sentiment, as interest rates play a huge role affecting the supply and demand of currencies. Every currency in the world has interest rates attached to them, and these rates are decided by central banks. For example, the Fed in the US determines the country’s interest rates; the Bank of Japan (BOJ) sets Japan’s interest rates; the Reserve Bank of New Zealand (RBNZ) decides on New Zealand’s interest rates and so on. Some currencies have higher interest rates than others, and these are usually the currencies that attract the most attention from savvy international investors who are always looking across the global landscape in the continual search for a better interest rate yield on fixed-income investments. This, of course, also depends on the geopolitical or economic risks of that particular currency. Just like when a bank lends money to a higher-risk borrower, high-risk currencies require a significantly higher interest rate for investors to consider keeping money in those currencies.
WHAT CAUSES FLUCTUATIONS IN INTEREST RATES?
The value of money can and does decrease when there is an upward revision of prices of most goods and services in a country. Generally, when a country’s economy expands or when energy costs go up, goods ranging from clothing, food to computers, and services ranging from public transport to spa treatments get more expensive, thus eroding the value of money. The nice word for this erosion in value is, of course, inflation.
Controlling inflation
Central banks are responsible for ensuring price stability in their own country, and one of the ways they employ to fight inflationary pressures is through the setting of interest rates. If inflation risks are seen to be edging upward in, say, the US, the Fed would raise the federal funds rate, which is the rate at which banks charge each other for overnight loans.
When the overnight rate is changed, retail banks will change their prime lending rates accordingly, hence affecting businesses and individuals. An increase in interest rates is an attempt to make money more expensive to borrow so that there will be a gradual decrease in demand for that currency, thus slowing down an overheated economy. The opposite scenario is true too: when a country faces deflation, or even decreased inflation, which is often the result of decreased spending, whether by the government, consumers or investors, it prompts the central bank to lower interest rates so as to stimulate spending.Interest rates and currencies
The most important way in which interest rates can influence currency prices is through the widespread practice of the carry trade. A carry trade involves the borrowing and subsequent selling of a certain currency with a relatively low interest rate, then using the funds to buy a currency which gives a higher interest rate, in an attempt to gain the difference between these two rates – which is known as the interest rate differential. The trader is paid interest on the currency he or she is long in, and must pay interest on the currency he or she is shorting. This difference is the cost of carry. Therefore, a currency with a higher interest rate tends to be highly sought after by investors looking for a higher return on their investments.
Rising interest rates in a country tends to strengthen that country’s currency relative to other currencies as investors exchange other currencies to buy the currency of that country when they transfer their assets into the country with the higher interest rates. The increased demand for that particular currency will thus push up the currency price against other currencies.
About Kuldeep Nikam
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