Sentiment can be
described simply as the mood of the market. Sentiment should be the primary
concern for short-term traders.

It can last an hour, a
session, a day or weeks depending on what is causing it and how much importance
the market gives it. Thus, you have to identify the reasons why the market
behaves in a certain way.

Risk sentiment can be
fickle. You will see sometimes the market focusing on something and moving
accordingly but then suddenly something else happens and the previous concern
is completely forgotten.

You should also take note
of which session is driving the sentiment, because if you get some risk off in
the European session due to some negative piece of news, it doesn’t mean it
will be taken as equally negative in the North American session.

This may be due to
further reports calming down the waters or just not in line with the prevailing
theme, so it may be actually traded in the opposite direction in the new
session with traders taking advantage of better prices.

These swings in risk
sentiment are generally triggered by fundamental catalysts. That’s why it’s
vital that you keep yourself updated on the latest developments because
sentiment can go against the big picture fundamentals and if you are trying to
enter in line with the fundamentals but against the current sentiment, you may
find yourself in trouble with prices that keep going against you.

It’s better to align
sentiment with big picture fundamentals for the best results.

RISK-ON/RISK-OFF

The two types of
sentiment are risk-on and risk-off.

• Risk-on is when the market doesn’t see
  risks and you will often see risk assets like equities, commodities and commodity
  currencies rallying. Basically, assets that give a high yield or more bang for
  the buck.
• Risk-off, on the other
  hand, is when the market does see risks and goes for safer assets, like
  bonds, safe-haven currencies and so on.

Generally speaking, positive
economic growth or expectation of more growth leads to risk-on sentiment while a
negative growth picture triggers the risk-off regime.

WHY IT’S IMPORTANT?

Knowing the risk sentiment regime is fundamental. For example, if someone
were to tell you that the S&P 500 is up 5% on the day, you could guess that
the Australian Dollar or copper were also up on the day without even looking at
the charts.

One of the main reasons for such correlation is the economic
interrelationship between the various assets, which got stronger and stronger
with financial globalization.

The concept of risk sentiment is also very important in selecting the
assets that will move the most during different types of sentiment. For example,
during risk-on, you will see lots of stocks rallying but some of them will increase
much more than others. In the FX space, you might see emerging market currencies
appreciating faster and providing you with great carry trades.

This article was written by Giuseppe Dellamotta at www.forexlive.com.