When many traders talk about analyzing currency movement, they tend to focus on two separate methods – fundamental and technical – but these do not give you the market psychology.
Here we outline two powerful tools, that can be used to analyze currency movement, and work with either the fundamental, or technical method – and help you to spot the really bid trend changes.
When analyzing currency movements the following equation applications:
Supply & Demand Fundamentals + Investor psychology = Price action
Fundamental analysis does not make any effort to study investor psychology – whereas technical analysis does so – in terms of repetitive price patterns. However, technical analysis still does not predict when a price pattern is at an extreme – it simply follows market action.
Spotting Market Tops and Bottoms in Advance
What if you knew in advance:
1. What investors were thinking
2. What investors were doing
In addition, you could spot if they have pushed a trend too far with the emotions of greed and fear.
How useful would that information be? – You could spot big potential market tops, or bottoms in advance, and make huge profits!
That's, exactly what the two tools can do for you – and they're free!
The Importance of Market Psychology
In any investment market, we know that investor psychology is vitally important when analyzing currency movements – as investors push prices too far in either direction, as the emotions of greed and fear come into play.
Investors push prices away from fair value – and then prices recoil in the other direction.
Ever surprised why big price moves take place when the market is at its most bullish, or bearish? – This is investor psychology at work.
So, How can we Measure Investor Psychology?
There are two powerful tools you can use – and they can help you spot every major top and bottom – yet few traders use them!
Here are the two tools:
1. The Commitment of Traders Report
This is published bi weekly by the US government and breaks down the open interest of the US futures markets, (which include treaties) into three separate groups:
Commercial hedgers – These are savvy traders who are hedging, not speculating – and they are unaffected by the emotions of greed and fear.
Large speculators – These are mostly funds, who are trend following – and always get caught at turning points.
Small speculators – This represents small individual traders – and they are the worst traders of all, as they are mainly motivated by the emotions of greed and fear
Profiting from Tracking the Pros
So, what use are these positions? – Commercials are hedging, and if prices spike too far from fair value, the commercials will move aggressively the other way – starting a buying frenzy – and the buying price collapses when they have gone too far.
The Commercials are hedging – so no greed or fear comes into play – they are just looking at the facts. When you have an aggressive price move, and commercials trade in the opposite way to the trend, and the positions of large and small speculators – then a trend change is imminent.
A Word of Caution
When analyzing currency movements with net traders positions, it is important to only trade extremes. If you watch for these extremes, and trade with the commercials you can catch the big turning points.
2. Percent Bullish
This is a good backup tool to the Commitment of Traders Report, and is a poll of investors; brokers, fund managers, etc. – Percent bullish expresses their bullishness as a percentage.
Traders in currencies should look for a figure below 20%, to indicate a market that's too bearish – and above 80%, for a market that's to bullish. When these numbers are hit – look closely at commercial selling and buying – if they line up, get ready for a turning point.