This is actually one of my favorite subjects, Sentiment Trading. Sentiment trading is basically trading with market sentiments. The concept is pretty simple, find out what the market sentiment is, and place a trade in the direction of market sentiment.
So, how can we find out what is the market sentiment? Well, look at this 4-hour chart below; can you spot a trend? That is pretty much your long-term market sentiment.
There are actually 2 types of market sentiment, one being long term sentiment and the other being short term. We cannot really take advantage of the long term sentiment as retail traders, because we don’t have the financial backing to sit through market volatility; however, short term sentiment is where we can make good money.
Short term sentiment is driven by fundamental news. If the market is expecting a better than forecasted news release, it will try to price in the outcome days before the actual news release. It is often called “Buy Rumor and Sell Fact”. For example, if the market is expecting ECB to raise interest rate next week, we will see EUR/USD going up few days, even a week before the actual ECB announcement, to price in the rate hike. During the actual interest rate announcement, where the market has already priced in the hike, might start to SELL EUR/USD and drive market lower as major players scramble to cover their original long orders and take profits.