How to fade sentiment

Fading sentiment is a common market maxim. . Now the term sentiment simply means the current mood of the market. The market, like people, has different moods. For example, sometimes the market is in a risk off mood. At other times the market is in a risk on mood. You might come to your desk in the morning and see that there is some key data out for a currency pair that is causing it to be heavily bought. All these are examples of market sentiment.

Some sentiment is more important than others

There is a hierarchy of sentiment which simply means that some market moods are more important than others. Once you have understood this point you are now in a position to understand how to fade certain sentiment. The market, like a person, can have unstable moods. Sometimes the market is unduly happy or sad. The market can move in extremes in certain moods and you have to learn to recognise the importance of the different moods. Fading sentiment involves ignoring the reaction to one of the markets moods in favour of a stronger, and more important mood.

An example of when to look to fade sentiment

Understanding when to fade sentiment is best explained with an example. On Wednesday 8 August 2018 the Reserve Bank of New Zealand surprised the market with their monetary policy statement. In the statement they revealed that they would be keeping interest rates at a lower rate for longer. See here for the current interest rates for the countries across the world. The exact wording used was as follows:

"The Official Cash Rate (OCR) remains at 1.75 percent. We expect to keep the OCR at this level through 2019 and into 2020, longer than we projected in our May Statement. The direction of our next OCR move could be up or down"

The official statement can be read here.This mood or sentiment now became the most important mood for the NZD currency. You can see the reaction the market had in selling the NZD over the next week and beyond.

The central bank had been very clear. They would be keeping interest rates at a lower level for a lower period of time. This meant that the New Zealand Dollar will weaken in the coming session /sessions. Now, the important part of fading sentiment would then be to have a smaller, and less important mood which caused the NZD to be bought. Now this could have been some positive PPI readings or some good retail sales data or a positive comment from a high ranking NZD official. Essentially anything that would have given the market a positive NZD mood. This is where the well informed trader would be looking to do the opposite of what that smaller, less important mood is doing. So, even though the short term sentiment is to buy the NZD, the more important sentiment is to sell the NZD. This is because the monetary ploci In this way the trader can be said to be, 'fading the market's sentiment'.

So, this is what you need to remember in order to be able to fade sentiment yourself:

  • Firstly, wait for a key and big mood/sentiment shift for a currency. This could be a surprise interest rate hike, a change in interest rate projection as outlined by the RBNZ example above. However, you need to ensure that the data is significant.
  • Secondly, consider less important moods, which contradict the most important mood, as opportunities to 'fade'.