Sentiment, like food, is best enjoyed 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 always want to know what the current sentiment is. Trading sentiment is a basic market skill as we try to make sure we are always trading in line with market sentiment, unless 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, that changing sentiment provides opportunities.
Not all sentiment is equal
One of the challenges of trading sentiment is that there is a plethora of different data points and comments every day 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. 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. This is an excerpt from last week’s full rundown on the BoC:
“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 in that direction. Also, we know that the BoC are not reluctant to cut interest rates and surprise 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; it was better to move on to the next opportunity.
The key takeaway
The key point is that the market-moving event with the most influence would have been a negative CPI print. In this case, we could have been poised and ready to take an immediate CAD short out of the event; it would have been a high conviction trade. So, when selecting a decent sentiment trade you should see:
• 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 on to the next principle, trading sentiment while it is still fresh.
Trade sentiment while it’s 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. You missed trading out of the event because you were away from your desk, at sleep, or at work but there is often a second chance to enter a trade on that sentiment in the next 24-48 hours. If you don’t want to just chase the selling or buying price at market, an alternative would be to wait for a retracement to a key level before trading back down to those prior lows. Below is an example of a trade I took this 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% Fibonacci level and took profits at the prior high. Check out the chart below; my entry is denoted by the small blue arrow and my exit by the small red arrow. My order was filled about 12+ hours after the minutes, but I still got it while it was fresh.
So, there you have it, sentiment is a dish best served fresh. What sentiment trades are you looking into for the coming week?