The key to trading fresh sentiment
Sentiment, like food, is best traded fresh.
Firstly, what is sentiment?
Sentiment is, quite simply, the present mood of the market. The market, like people, has different moods depending on what has just happened. As traders we are always wanting to know what the current sentiment is. Now, trading sentiment is a basic market skill as we try to make sure we are always trading in line with market sentiment (Unless of course we are fading market sentiment, which is a valid pursuit, but the subject of a different article). So, what are the keys to trading fresh sentiment? In this article I will briefly present the case that the two key concepts to trading fresh sentiment are as follows:
- Picking which sentiment change to focus on and;
- Trading that sentiment while it is still fresh
Picking which sentiment to focus on
The very best time to trade sentiment is when we notice the sentiment change. Sentiment can change on a number of different issues. It could be a surprise data point, a political development or some other unexpected event that causes a currency to move. The point is, we have our opportunity from changing sentiment.
Not all sentiment is equal
One of the challenges of trading sentiment is that every day there is a plethora of different data points and comments that flow across feeds. Not all of those data points move the market, so the first thing to realise is that sentiment varies in importance. Now, this is obvious in that a central bank interest rate decision holds far more sway over a currency than a retail sales release. However, aside from the stark and self-evident differences, it is important to recognise which sentiment is going to be important ahead of the event. Let's take a worked example with the CPI data released on Wednesday for Canada.
Canadian CPI this week
The Canadian CPI data release was my key focus for this week as it was widely known, prior to the CPI release, that the Bank of Canada was in a unique position amongst its central bank peers. See here for the full rundown on the BoC I wrote last week where I commented:
"The Bank of Canada remains the only major central bank to not turn explicitly dovish. However, in an increasingly bearish central bank world the pressure is increasing on the Bank of Canada to follow suit"
This means that the market was just waiting for a reason to sell CAD as the expectations were that the BoC will follow their central bank peers. They just need a data reason to nudge them that direction. Also, we know that the BoC are not reluctant in cutting interest rates and surprising the markets, as they did here in 2015.
So, that sets the expectations for the potential of a strong CAD sell off if the CPI print was a negative read. That would be the ammunition to fuel increased expectations of a coming BoC dovish tilt, the sentiment change. This would have resulted in a strong sell off for CAD. In the event, the release was a positive uptick in inflation, so the chances of a September rate cut from the BoC faded into the background. The trade was not there. Move on to the next opportunity.
The key takeaway
The key point is that the market moving event, with the most force behind it,would have been the negative CPI print. In this way, we could be poised and ready to take an immediate CAD short out of the event. It would have been a high conviction trade.So, you need the following elements for a decent sentiment trade:
- A clear bias going into the event
- A data release or event that clearly confirms or contradicts that bias. In other words it is clear that the market will respond in a certain way.
Now let's move onto the next principle, trading sentiment while it is still fresh.
Trade the sentiment while it is still fresh
Let's say, for the sake of argument, that you took a similar trade like the one outlined above that actually played out. Now, you missed trading out of the event because you were away from your desk, at sleep or at work etc. There is often a second chance to enter a trade on that sentiment in the next 24-48 hours. Now, you don't want to just chase the price selling or buying at market. So, in these scenarios wait for a retracement to a key level. Then trade back down to those prior lows. Below is an example of a trade I took this the week on the AUD/NZD pair that illustrates this.
AUDNZD: An example of trading sentiment while still fresh
I have been core long on AUDNZD since August 07 and remain so at the time of writing. You can read my reasons for that in the previous links, but the bottom line for the AUDNZD longs was the growing diverging outlook between the RBA and the RBNZ. The RBA minutes out on Tuesday this week further confirmed that divergence and the market chances of a rate cut from the RBA went down to ~12% from ~50% the previous week. So, having missed the release of the minutes overnight I set orders to buy on stop around the 50% Fib level and took profits at the prior's high. Check out the details below. My entry is the small blue arrow and exit the small red arrow. My order was filled about 12+ hours after the minutes, but I got it while it was still fresh.
So, there you have it. Sentiment is a dish best served fresh. I like the look of the NZD business confidence data out next week with the RBNZ making it their focus. A weak print will confirm that bearish bias for the NZD and I favour, at time of writing, AUDNZD longs on a weak print.
Yesterday provided another excellent opportunity for a fresh sentiment trade to take AUDJPY shorts. With risk clearly off as China retaliated against US tariffs the JPY stood to gain in safe haven flows. The AUD stood to lose due to its close relationship to CHina's economy. An AUDJPY short made obvious sense and it was reasonable to expect sellers. Here was the post I made to HYCM's telegram channel just before the large AUDJPY drop (where I work as the Chief Currency Analyst).
So, trading fresh sentiment is a good source of profitable trades and I am pleased that I closed out Friday with such a clear example. Not to mention that it was very nice to come back to 70/80+ points on a AUDJPY trade, and I know forexlive readers will all appreciate that warm glow;-).
What sentiment trades are you looking at for the coming week? Please post in the comments section below and help reinforce this concept.