Great counter-indicator – retail sentiment
I’m sure you’ve heard or read that most forex traders are constantly losing money. Unfortunately, that is true. Many people engage in forex trading without proper education and training, which makes them vulnerable to losses. Most individuals underestimate the formidable challenge of trading financial markets.
The trend is your friend
The most important principle of trading is trading in the direction of prevailing trends. Most retailers do not follow this rule and therefore constantly lose money.
Retail positioning and strong trends
As we know, retailers generally oppose strong trends instead of keeping up with those trends.
Why is this happening? An important reason is that retailers like to pick tops and bottoms in strong trends. They like to ‘buy low’ and ‘sell high’.
When market trends drop and fall to fresh lows, these traders feel that a low price is a good price to buy. Conversely, when the price drops to the highest peaks in a strong bullish trend, they sell because they think the price is really expensive.
While there is nothing wrong with buying low and selling high, you should do so in the direction of the trend, not against it.
Retailers also tend to trade at lower time frames, which are usually much less reliable than higher time frames like daily and weekly.
For example, an inexperienced retailer would sell during a fall on a five-minute chart that moves relative to a really strong growth trend on a daily chart. If he’s lucky, he’ll earn a few pips, but institutional players trading ‘with the trend’ at higher time frames are likely to take his money.
Retail positioning can be an amazing tool for acknowledging strong trends, pointing out possible trend reversals, and avoiding market consolidation.
Practical examples
Let’s look at current retail positioning data on several major instruments:
Dailyfx.com SSI index
SSI stands for Speculative Mood Index. This tool tells you how many retailers there are and how many they lack in a particular currency pair (or other financial instrument).
Take EUR / USD for example. The number we see here is -2.4868. This means that for every open long trade there are 2.4868 open short trades. This means that 28.68% of the open exposure to EUR / USD is currently on the buying side and 71.32% on the selling side.
Now let’s look at what EUR / USD did:
Here you can see that EUR / USD has been trading more for several weeks now. The price is currently above 200-MA and 20-EMA which confirms the bullish direction of the trend.
Today’s decision by the ECB and a press conference weighed on the euro, but the broader picture remains strong despite the correction of the counter-trend.
In the table above, you will notice other characteristics of the uptrend – higher momentum and higher lowest momentum.
The upward trend is obvious. However, retailers are aggressively selling this rise and losing money.
You’ll probably be surprised to learn that retailers have been net of EUR / USD since April 18 this year. Since closing on April 18, the EUR / USD exchange rate has risen by 486 pips.
It is obvious that most of these traders have been wiped out of trading, and those who are still holding on to their short positions are on their hind legs and sitting with a big loss.
At USD / JPY, the current SSI value is 1.92. This means that for every short position there are 1.92 long positions. This results in 65.71% long positions and 34.29% short positions.
Just like with EUR / USD, retailers have been fighting the fall of USD / JPY for a long time, even since May 18 this year. (On this day, retailers have turned into a net network).
At the moment, the USD / JPY SSI reading is 1.92, which is not too extreme, but if we see a continuation of the decline next week, this reading could quickly move above 2.0. Watch out for this couple!
Although we are busy USD / JPY, keep in mind that next week we have some risks from high-level events that could have a huge impact on this pair. The Fed (Federal Reserve) and BOJ (Bank of Japan) make interest decisions on Wednesday and Friday, respectively.
To learn more about USD / JPY trading, simply follow this link: USD / JPY Currency Pair Trading – A Beginner’s Guide.
How retail positioning data is used
Do you notice how retailers like to fade strong market moves?
What is so phenomenal about this great indicator is that extremely strong trends are often accompanied by extreme SSI readings.
This feature allows us to build a trading strategy around this concept. Some say readings above 2.0 or below -2.0 should be considered extreme (and useful for trading purposes). Others like to trade when the readings are above 3.0 or below -3.0.
Strategies and techniques
Usually SSI readings above 2.0 and below -2.0 give good results.
Example EUR / USD
When we have a strong upward trend, for example, to EUR / USD, and SSI readings are below -2.0, we can investigate the situation and be looking for buying opportunities.
From negative SSI reading we know that most retailers are on the rise. We want to trade against these people, and with a trend just like institutional players.
To land the plane safely, you need to approach the runway against the wind. To make money in the markets, you need to trade against the sentiment of retail.
At the moment, however, the upward trend of EUR / USD is approaching an important resistance zone on the weekly chart. Still, if we get a good bounce candle in the region of the 20-day exponential moving average, a good buying opportunity could arise.
It should be borne in mind that today’s meeting of the ECB had a negative impact on the euro. Personally, I would like to see solid confirmation that the upward trend continues before entering the long trade. In case this ECB meeting was a catalyst for reversing the trend to EUR / USD.
If you want to know more about trading EUR / USD, follow this link: Currency pair EUR / USD – Beginner’s guide.
How to trade extremely strong, non-volatile trends
Trading really strong, unchanging trends with SSI can be tricky if you don’t know how to approach them. There are often few significant re-steps on daily charts that we could take advantage of in these conditions.
This problem can be circumvented by trading shallow entries in smaller time frames or trading by punching on daily charts. Breakthroughs can also be traded on smaller time frames, of course.
For more detailed information on these trading techniques, follow the following link: How to understand the different market structures.
In this article, you will also learn how to effectively trade volatile trends.
Of course, it is crucial to properly analyze the instrument you want to trade, not just trade it, because the SSI reading is extreme.
You need to handle each instrument individually and keep in mind important fundamental and technical factors when making trading decisions.
Exotic and smaller pairs / instruments
Reliable retail positioning data is usually not available on less significant instruments such as exotic and smaller currency pairs. However, the same principles apply when trading these instruments.
As the steady trend accelerates, retailers fight it with renewed determination. As the trend progresses, these traders are forced to abandon their counter-trend positions. Their stop losses are activated or their positions are forcibly closed when their accounts run out of available margins.
The big boys (mostly institutional traders) who trade with the trend collect the money of these traders with ease.
So while you may not be able to access retail positioning data on certain instruments, you can trade them in the same way as major currency pairs.
Something to keep in mind is that retailers are sometimes on the right side of the market, especially in a variety of environments. However, retailers make mistakes most of the time and trading against retail sentiment is really helpful when you combine it with sound technical analysis and good money management.
Have you tried our trading signals? Not only do we provide signals for forex trading, but also signals for gold, crude oil and the Nikkei 225 stock index.
Happy trading!