Top 7 things You Didn't Know About Market Sentiment Trading Set Ups !

This is common sense and part of our daily experience that When driving a car on the highway, we do not notice all of the details of all of the cars near us. We only pay attention when a car in front of us is swerving. It is a break in the pattern. It is a signal to act upon. From a sentiment point of view, a signal is a change in the sentiment direction and in the particular alignment of sentiment in multiple time frames. Signals and set-ups can be sorted into two types: Position Trading Signals and Momentum Trading Signals.

1. Position Trading Sentiment Set-Ups

A position trade is characterized by a longer duration where the trader is riding a strong sentiment force. Positions can have durations of going beyond a day and sometimes can be several weeks. Sentiment analysis can assist the trader in pinpointing the direction and where to enter.

At least two time frames are necessary for a sentiment position trade. First a higher time frame and then a lower time frame. The higher time frame provides a background verification of the strength and direction of the sentiment. A lower time frame provides a trigger for entry. Three duration views are also acceptable and provide extra granularity for detecting sentiment. The key point is to enter only in the direction of the higher time frame. Deciding which time frames should be used depends a great deal on the style of the trading. A position trader, looking for inter-week positions might choose a weekly duration as the higher time frame, and a daily duration as a lower time frame. A day and a two hour is another combination. A six hour and a 30 minute combination is also worth exploring.

How about timing the entry? If a trader wants to go long, should the chart be pointing into an upward direction? If a trader wants to go short, should the chart be pointing into a downward direction? The answer is not that straightforward. The critical factor for entry is the condition that prices, even though are moving in a certain direction, have had a pull-back which is followed by a reversal back in the prior direction. In other words, the price tried to reverse direction, it did, but failed and swung back. The swing back makes the optimal entry point the moment when the prices are moving back toward the higher time frame direction! This can be called a U-turn, named after a car shifting directions from going one way to the opposite way. Hopefully, it is a legal U-turn.

A good way to visualize the power of the U-turn as a trading signal is the analogy of a car moving fast approaching a curve. The angular momentum makes it difficult for the car to slow down and straighten out. Similarly, when a price pulls back and then turns back around, the energy is of high momentum and is likely to carry the price much further. A U-turn or swing back shown in 3 line break charts provide a high-level of confirmation that sentiment has reversed and into the higher 3 line break time frame.

2. Sentiment Alignments for Position Trading

Let us examine several snapshots of possible alignments for a sentiment position trade, and explore which alignments offer a high probable position trade set-up.

Sentiment condition: Conflict between one-hour and four-hour sentiment: No condition to trade.

In the following chart (Chart) we can see that the four-hour, three-line break chart for the AUDUSD is showing a sequence of three consecutive new four-hour high closes. This is depicted in white. We see a large white line break reversal followed by a thin new four-hour high close. But then it was followed by a bigger move to a new high close. Seeing this condition, the trader is biased to be looking for a buying opportunity.

A next step would be to monitor what the one-hour three-line conditions are (Chart). The most important condition to detect is whether the lower time frame, in this case the one hour, is aligned in the same direction of the higher time frame (four hour). The latest line break pattern on the one hour AUDUSD is clearly black and therefore it is not aligned. Going long is not permitted. The trader would have to wait for the one hour to reverse back into the direction of the four hour, three line.

Sentiment condition: Alignment between four-hour and one-hour three-line break: With alignment of a lower one-hour line break.

In this next example of an alignment match we see clearly that the four-hour USDJPY (Chart) is bullish having had a strong white line break reversal followed by a second new high close. This followed a sequence of bearish black line breaks. The trader can immediately conclude that there is permission to buy and the bullish sentiment is strong. But the next step is to see if there is an alignment of the lower one-hour line break (Chart) in the same direction of the four-hour line break chart. The trader seeing this alignment can enter the trade at the market because the bullish sentiment has reversed in the direction of the higher time frame, and in fact is pushing higher.

3. Sentiment condition: Bearish alignment.

Let us consider a scenario where there is a bearish alignment between a lower and higher time frame

The four-hour three-line pattern shows a reversal of sentiment into a bearish direction with three consecutive new low four-hour closes. The task now is to go to the lower time frame and see if it is aligned.

In this case, we can see that the lower five-minute three-line GBPNZD pattern had a sequence of bullish moves, and then a bearish reversal (Chart). It therefore aligns with the higher four-hour time frame. It is a signal to go short at the market. It is a strong signal because the lower time frame has experienced a reversal 3 line break in the direction of the higher time frame. This is an optimal moment to catch. It is useful to note, that even if the trader misses the close of the lower time frame reversal, if the next 3 line close follows in the direction, it is an acceptable trading entry.

4. What about Limits and Stops

In a position sentiment trade, when the excursion of the trade takes time, it incurs the increased risk of being wrong. A position trade is difficult to watch as traders are busy and also reluctant to be slaves to the screen. Therefore, the trader needs to not only ride the direction of sentiment, but also needs to ride the mathematics of the profitability curve. An initial good place to determine a stop and limit strategy is to commit to a reward to risk ratio of 2:1 The trader would put on the market order, for example, to sell, and locate a stop above the previous high close (the white candle before the reversal). The distance between the stop and the market order is the risk and it can vary. The key point is that once the stop is selected, the risk is calculated. Let us call it X. The take profit target in the position trade should at least be 2X.


This ratio should be the standard applied to each trade. Why? It is because if one is 50% right in the trade, the approach is profitable. Most traders have little patience to do a “stress-test” on their trading strategies. It is a good idea to take the measure of one’s performance, every ten trades, and quantify the average profit per trade, and the average risk per trade. Does it match the 2:1 target? Each ten trade series provides a check-up on the health of the strategy. The downside of this approach is the human factor, where traders have no patience and are not disciplined to stick to the rules. Actually, an effective quick improvement in performance will be accomplished by moving the original stop loss to a break-even position. Then the trader has a free ride!

By using the mathematics of profitability as a key rule for placing limits and stops, the trader still needs to locate the initial stop and limit, if a position trade is being used. A good approach is to put on a market order to buy when a new high close occurs on the lower time frame. The stop would be then below the previous low close. How far below? Enough to allow the market to vibrate. Then the limit would be located 2× the risk distance. Selling is just the exact opposite. The sell order is placed at the close that the three-line has turned from a bull into the bearish direction (black). The stop is located above the previous high close, and the sell limit target is simply 2× the risk 

This is simple mathematics. What we are saying is that the goal is to achieve profitability with 50% being right as a first step. After that, optimizing the performance can occur in many ways by examining alternative time frames, and market situations. But profitability is the first goal of any trading.

5. Back Tests

It is useful to get a sense of the profitability potential of using line break position trading described in this chapter. In this example (Table), the strategy was back tested using the four-hour three-line, and one-hour three-line, on the GBPJPY as a trigger. This was a set-and-let strategy. We let the system work on its own. No stops were moved to a break-even point.

Total trades	31
Net pips	729
Total winning trades	16
Net winning pips	1483
Average winning pips	92
Total losing trades	15
Net losing pips	−754
Average losing pips	−50
Net %P/L	5.0819

Back test GBPJPY August 7–November 14, 2017

In Table we did a back test on the GBPJPY using the four-hour three-line, and one-hour three-line strategy. It met the important parameters of profitability. The average win/loss ratio was 16:15, which is essentially break even. However, the average winning pips was 92 versus the average losing pips of −50. The wins were 1.84 × the average loss, generating a profitable system. Once again, keep in mind that this is an unmanaged result. No stops were moved to break even, which would significantly increase the overall profitability.

Another back test was of the GBPUSD using a four-hour three-line, and a one-hour three-line for alignment. In this case we had a win/loss ratio that is actually negative (14 wins/21 losing trades). But the average gain/average loss was quite large: 86/37 for a ratio of 2.3. It is useful to note that this was totally unmanaged

Total trades	35
Net pips	425
Total winning trades	14
Net winning pips	1214
Average winning pips	86
Total losing trades	21
Net losing pips	−789
Average losing pips	−37
Net %P/L	2.324324

Back test GBPUSD four-hour three-line, and one-hour three-line, August 3, 2017–November 17, 2017

These back tests suggest that the potential of profits aligning a lower with a higher three-line break time frame is strong. The most important testing is forward testing of these strategies. The best way to do this is in a live account trading at only 1:1 leverage. For example, a 10,000 account would permit a nominal position size of 10,000 on a trade. This is commonly known as a mini-lot. A standard lot is 100,000 generating a value of approximately $10 per pip. This may vary slightly depending on the currency pair traded.

6. Momentum Sentiment Trading: FX Rodeo

Momentum sentiment trading is one of the most exciting set-ups and is the opposite of position trades. It requires no target, no limits, and no stops! It is purely riding the sentiment wave! In it, the trader experiences the sentiment rather than analyzes it. Another way to understand the basics of this momentum set-up is through the analogy of the rodeo. In the classic American cowboy western rodeo, the cowboy sits on a bull locked in behind a gate. The gate opens and the cowboy is challenged to stay on that bull until it throws him off! 

In these bull-riding rodeos, eight seconds is considered to be champion duration. What is most interesting is that the cowboy gets thrown off when he anticipates the underlying movement of the bull. If the bull surprises the cowboy and sways another way, he is thrown off. So, let us visualize a sentiment trade as an FX Rodeo. The underlying currency pair is the animal. If we are buying the USDJPY, then one can call it a dollar bull ride. f one is selling the USDJPY, then one can call it a yen bull ride. That keeps the analogy intact!

Before we trigger the entry, first we need to confirm that there is an alignment of sentiment of the lower time frame with the higher time frame. But the critical momentum trade signal is when the one-minute Renko aligns with the five-minute three-line. For this sentiment wave rider, or FX Rodeo strategy, a five-minute three-line chart would be very useful. We can see that the five-minute three-line is USDCAD.

We want to ensure that at a micro-detection level, there is also the same sentiment to enter the position. To do this we turn to the Renko bricks.

Let us look at a trade trigger using Renko. The trader in Chart  is looking to sell and the trigger condition would be only if the Renko bricks had shifted from a sequence of white bricks to black bearish bricks. The trader seeing this shift can enter a sell trade in the market. The alignments are solid as the one-minute Renko is confirming a persistence down and is aligned with the five-minute three-line. 

The five-minute three-line is assumed to be aligned with a higher time frame. A buy trigger is exactly the opposite with the 10 pip Renko bricks shifting into a bullish reversal with one or two bricks breaking out of resistance (Chart). It is useful to note that there is not a prescribed number of Renko bricks that would trigger an entry or an exit. The key is whether the price has shown a confirming shift in direction.

7. Where are the Stops and Limits?

One might be tempted to ask: where are the stops , where are the targets? How does one stay on the trade? The trader simply stays on until there is evidence against the direction. The evidence is the emergence of Renko bricks in the opposite direction of the trade. 

As soon as a Renko brick 10 pips is closed of the opposite color, jump off. This means, realistically, that the risks to the trade is 10–15 pips because of possible slippage movement. It also means that the sentiment direction can continue to go a significant distance into very nice profits of 50 or more pips!

An important effect of this strategy is also how it augments profits. Consider the dilemma facing the forex trader when the trade reaches a target level. Should he get out? Most traders just get out when they reached a target. This has a logic to it, but it is flawed because the reason to get out should be when there is evidence of a rising threat against the position. 

Since commonly used technical analysis set-ups simply provide a target, it is understandable that a trader gets out when the target is reached. But it is not optimal. Too often getting out at a take profit limit leaves money on the table as the price continues to go in the direction of more profits. With the one-minute 10 pip Renko bricks the trader can stay in longer beyond a target.

The take-away from using this strategy should be that it is a pure price action/momentum trade. The alignment sets up the trade, but the entry is pure Renko breakout. The trader simply rides the sentiment, without being encumbered by intentions. Let the price action work its way. 

The only task of the trade is to ride the animal spirit of the market! There is one more very important effect, and it is psychological. The sentiment momentum trade relieves thetrader of the burden of too much thinking and analytics. In fact the trade approximates pure experience.

Does this strategy generate profits? An example of a real trading record is shown in Table. The trader, Mr. G, a student of this technique, shows the following performance after initial training. From a period of April 2 to April 11, 40 trades were placed using the rules of FX Rodeo Momentum trading described in this chapter. 

Performance example

We have an excellent performance of 82.5% winning trades, and an average gain/average loss ratio of 1.4. The challenge ahead for this trader is to maintain this record as he takes on bigger positions.