Fundamental analysis is the study of economic releases and news events, while technical analysis is the study of price action through charts.

Transcription

1 There are two things that almost all traders strive to accomplish in their trading: accurately predicting the direction of the market and accurately timing the entries and exits of their trades. Often, fundamental analysis, technical analysis, or a combination of both are used to achieve these goals. Fundamental analysis is the study of economic releases and news events, while technical analysis is the study of price action through charts. In the stock and futures markets, some traders are fortunate enough to have access to a third tool to help accomplish these goals, which provides insight into what traders are thinking. This is often referred to as the sentiment of the market. Finding such information is accomplished by looking at positioning data in reports like the commitment of traders or the put to call ratio. These reports provide a quick overview of volume or openinterest, giving traders an idea of the current directional bias. However, the stock and futures markets are centralized, making it easy to provide this type of data. The foreign exchange markets are decentralized making it impossible to find uniform volume or open-interest data, this leaves most forex traders relying only on fundamental and technical data in their trade analysis. But DailyFX has taken measures to fill this gap by offering clients access to FXCM s proprietary volume and positioning information. This data provides live clients with an unparalleled view of forex market sentiment. Given that FXCM is one of the largest non-bank forex dealers, our SSI boasts access to one of the largest and likely one of the most representative samples of the broader retail FX market The SSI data is derived from over 150,000 live accounts in over 200 countries and is updated twice a day at the DailyFX+ website. The report provides information on how many traders are long or short certain currency pairs and how many traders are entering or exiting the market. This is just the type of information we need to look more closely at the sentiment of the forex market. Throughout the remainder of this video, we re going to show you what SSI is, why we feel it SSI is so important and how you can use it in your trading. The Speculative Sentiment Index is a contrarian indicator. This might seem a bit counterintuitive at first, but after looking at the historical characteristics of the SSI, this will make a bit more sense. 1 P a g e

2 Historically, retail forex traders tend to fade momentum meaning the majority of traders sell in an upward trending market and buy into a downward trending market. Essentially, they try to pick tops and bottoms. At face value, picking tops and bottoms makes a lot of sense. Remember, at the beginning of this the video the second thing we stated that most traders try to accomplish is accurately timing their entries and exits. So the logic behind selling at a top or buying at a bottom is reasonable. By doing so, you re simply trying to increase or optimize the potential outcome of a trade. The problem arises however, when traders first fail to accomplish point one, which was accurately predicting the direction of the market. As we previously mentioned, and as odd as this may sound, in trending market conditions, traders tend to sell into an uptrend and buy into a downtrend. Take a look at this chart. This is the EUR/USD from around October of 2006 until around June of There was such a sustained rally in the value of the euro relative to the dollar that traders were continually net short up until June of Presumably, the thought process was must have been, this can t be sustained forever. Certainly the EUR/USD has reached a top. Prices must begin falling soon. However, even with the serious upward momentum that had been established for years in the EUR/USD currency pair, most FXCM traders were net short the entire time. Not until June of 2008 did things change. At that time, net positioning on the EUR/USD shifted to net long and look what followed. 2 P a g e

3 The EUR/USD came crashing down. There are countless examples where this type of relationship is present in trending markets. And because of this the SSI can be an invaluable tool for a trend trader. So lets take a look at a typical SSI report and explain how to interpret its data so we can use it in our trading. After logging into DailyFX+ and clicking on the SSI button, you will see a report similar to this. The primary data to consider is the positioning data found here. This chart shows whether traders are net long or net short the given currency pair. Positive numbers represent net long and negative numbers represent net short. 3 P a g e

4 For example, at the top of the chart you can see the number next to the EUR/USD. This means that there are 1.02 traders short the EUR/USD for every one 1 trader that is long the EUR/USD. Looking at the USD/CHF currency pair, we can see that there are 3.39 traders long the USD/CHF for every 1 trader that is short the USD/CHF. From this chart we want to examine two things. First, we look to see if traders are net long or net short. As a contrarian indicator, if more traders are long a currency pair the bias should be then to take for short positions or positions to sell. At the same time, if more traders are short a currency pair the bias should be to go long or to buy the pair. Additionally, you also need to consider the degree to which traders are net long short or net short long. For example, a ratio of positive or negative 3 should be taken as a stronger signal than a ratio of positive or negative 2. Essentially, the higher the ratio the stronger the bias to be long or short a particular pair. However, sentiment indicators like the SSI are not timing indicators. Just because the SSI reaches an extreme reading which would indicate that the trader should look for a buy or a sell, this doesn t mean that he should immediately jump into a trade blindly. SSI should be thought of as offering a directional bias. It can be used to decide whether you should be looking for buy positions or sell positions, but it will not tell you when to open a trade. This is where our traditional technical and fundamental analysis tools will better help us. When to buy or when to sell could be based on a certain technical indicator or candlestick formation, for example. But an extreme reading in the SSI can give us a bias to be either a buyer or a seller. It s also worth noting that the directional bias is strongest on a daily chart. If you are a short term trader trading on a 1-minute or 5-minute chart, the influence of that bias is going to be limited. But if your approach is to trade a bit longer term, say on the 4-hour or hourly chart, SSI can help you decide which currency pair to trade and in which direction to trade it. Let's take a look at a couple of charts with both the price of a currency pair and the SSI values plotted to get a better feel for the relationship. This is the chart of the USD/CAD currency pair with data between April 28 th and July 21 st. The green line represents the price of the USD/CAD while the blue background shows the SSI ratio for the pair. Remember, when the SSI is positive, we should be bearish and when the SSI is negative, we should be bullish. We also recommend that you look for extreme readings which are +2 or higher or -2 or lower. That is usually when potential for stronger 4 P a g e

5 moves is present. This chart starts with the SSI in positive territory with ratios consistently above +2 with even a few readings above +3. If we concentrate on the readings above +2, we can see where the market started selling off strongly when the SSI ratio moved up to +2 with selling pressure increasing as the ratio moved up to above +3. We can also see where the market found a bottom and reversed when the SSI moved back down below +2 and eventually moved down to negative territory. While the negative reading never moved below -2, the market did attempt to rally on the negative ratio. That rally was short-lived as the ratio quickly moved back to positive territory and then quickly up above the +2 level. We can also see where the market sold off strongly on that move up to extreme positive readings. This chart shows that traders should pay attention to moves from negative to positive and vice versa, but to once again look for extreme readings above +2 or below -2 for a strong bias worth working into a trading approach. Let's take a look at another pair to further confirm our analysis. 5 P a g e

6 This is the chart of for the GBP/USD currency pair with data between April 28 th and July 21 st. The green line represents the price of the GBP/USD while the blue background shows the SSI ratio for the pair. This chart starts with the SSI in negative territory with the GBP/USD moving up. In the middle of May, the SSI moved down to an extreme of below - 2 and we can see that at the same time the GBP/USD started to move up strongly. As the ratio moved from negative to positive, the GBP/USD found a top and sold off down to near the area. The SSI ratio then went negative again which resulted in the GBP/USD moving back up to previous highs. From there we can see that the pair would move up with a negative ratio and moved down with a positive ratio with extreme readings kind of shortlived. But once again, we can see where the SSI gives traders another way to see the market movement from a sentiment point of view. We ve only covered three examples in this video. However, the SSI data is updated twice a day at DailyFX+ giving traders many opportunities to observe the relationships that we ve discussed here today. The SSI can be a great tool but you have to make sure to use it properly and at the right times. Therefore, look for SSI to give the best directional biases when the markets are trending. Additionally, look for readings above positive 2 and below negative 2 to be the best times to take action. Lastly, because SSI is not a timing indicator and simply provides a directional bias, it is still necessary to use a technical indicator, or candlestick formation or something along those lines to find good entry and exit points for your trades. In closing, it s worth mentioning that this type of information is available internally at most banks and other FX firms. But because FXCM operates under a No Dealing Desk execution model, we have the privilege of providing our clients with many tools and resources like the SSI that we believe other Dealing Desk firms simply may not provide. Thanks for watching this video and good luck with your trading. 6 P a g e