How to use crowd behaviour to trade the markets - DailyFX Tips & Picks

Most retail traders consistently try to fade an ongoing trend. We don’t know why they do this, but it appears to be the “default” trading strategy of most new traders.

We know this because retail brokers publish “sentiment” indicators showing the positioning of their clients, and we can compare these with the price trend of the market. This information is often published exclusively for the broker’s clients, yet the latter keep ignoring it. But these indicators are highly useful.

A recent example was the sterling-dollar decline from $1.68 to $1.50. Throughout this 1,800 pips decline, traders decided to buy sterling. As the price trend shifted to bullish, most traders decided to sell sterling, even as the value was increasing. Price is 900 pips higher since the switch in positioning.

This example applies to most major FX pairs and equity markets. As an example, retail traders have consistently been short the S&P 500 since early 2013!

Given the success of the sentiment indicators and their frequent updates (minimum twice a day for brokers like FXCM), we can use them as trend indicators. The idea is to trade only against market positioning. The latest reading shows that for every long euro-dollar position there are 2.2 short positions. In the case of sterling-dollar, there are 1.18 short positions. With this in mind we should aim to be long euro-dollar or sterling-dollar. In the case of Kiwi-dollar, traders are net long by three times the value of short positions. This bodes well for our bearish forecast. Indeed, the FXCM SSI index has been bearish Kiwi-dollar since $0.7550 or +665 pips.

For more about sentiment and market positioning see http://bit.ly/Sentiment2015

Alejandro Zambrano is a currency strategy analyst at DailyFX.

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