With a daily transaction of over $5 Trillion, there is no doubt forex is the most liquid market in the world.
It makes sense that users associated with the market show signs of fear and greed. It’s in human nature wherever there is a considerable amount involved; fear and greed comes into play.
So, today we are going to talk about forex sentiment indicators measuring fear and greed.
But first, what are sentiment indicators.
Sentiment indicators show the ratio of open positions of traders at the current time. Some traders are bullish and hold long positions, while other traders are bearish and hold short positions. So, the sentiment indicator’s essence is to show the percentage of long and short positions open at any given moment in time.
Suppose a CFDs strategy gives a signal about buying an AUD / USD currency pair. The sentiment indicator shows overbought (the ratio of long and short positions is strongly shifted in favor of the buyers). You should refrain from such a deal.
That’s how sentiment indicators work.
With that said, let’s move on to indicators measuring fear and greed.
What are fear and greed indicators?
The fear and greed indicator shows the data on how traders will react to market conditions.
The greed index shows that people have overbought the currency pair, which increased the demand for the pair.
The fear index shows that people have oversold the currency pair, which decreases the price of the pair.
If you are confused about the definition mentioned above, there’s a mathematical representation that can help you.
Fear = People are selling more = Increase in supply of currency pair = decrease in price.
Greed = People are buying more = more demand for a currency pair = increase in price.
CNN’s fear and greed index were developed to measure two of the most important psychological factors in the financial markets.
It compromises of 7 charts:
- Stock price breadth: rising shares vs. declining shares
- Stock price strength: 52-week highs and lows of NYSE’s stocks
- Market volatility (VIX): measures the volatility
- Put and Call options: trading volume of bearish call options vs. bullish put options.
- Safe-haven demand: the difference between stocks vs. treasuries
- Market momentum: financial markets and their 125-day moving average
- Junk bond demand: the spread between yields on bonds and junk bonds
As you can guess, the fear and greed indicators were developed for measuring the stock market sentiment.
In the forex market, VIX, Put and Call options, and market momentum of fear and greed index is used.
How to use fear and greed indicators?
The value of indicators varies between 0 and 100. If the value is higher, this means the traders are getting greedier. Similarly, if the indicator shows lower values, there is a fear among traders. 50 is the neutral value.
In the forex market, when the indicators show greed, currencies like NZD and AUD perform well. In the case of fear, JPY and USD tend to do well, while EUR is somewhere between fear and greed.
The fear and greed sentiment indicators help know the overall market condition. As Warren Buffet pointed, “Be fearful when others are greedy, and greedy when others are fearful.”