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By Abe Confas
March 15, 2011
Dear Penny Sleuther,
There’s no question that we’re entering a tough environment for investors in March. All you have to do is look at today’s opening price action in the big indexes to see that traditional strategies are lacking — to really succeed in this market, you need to be able to incorporate market sentiment into your portfolio.
Today, I want to share some of the concepts that I utilize in my analysis of the markets when I look at trading opportunities for my Strategic Currency Trader subscribers. Sentiment is a crucial element of my strategy, but the challenge is to detect its shape…
There are very exciting new ways of detecting and charting the shape of sentiment and emotion in the market!
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Price charts are the common way to look at market sentiment. They reveal a lot about emotions and sentiment. How fast a price moves becomes a way to trace the momentum behind it. You can see the reaction to Trichet’s statement about “vigilance” regarding inflation in the Eurozone a couple of weeks ago. The EURUSD spiked up. The sentiment in this case was “surprise.” But more importantly, the price went into a sideways channel-signifying the emotion of stability.
In many ways, many of you already know a lot about market sentiment, because price action often follows the laws of physics which all of us are familiar with. Trader behavior often mimics the crowd behavior exhibited in the animal world. For example, traders and investors rush to join the crowd as if to protect themselves from predators. Buyers and Sellers carry out predator-prey scenarios.
There certainly is a lot of emotion in the market. At any moment, there is a battle between those who are buying and those who are selling. This is referred to as pressure. Buying pressure is often referred to as being bullish. Selling pressure is referred to as bearish. So we can use the concept of pressure to understand price action.
Another example from the sciences is the reference to a channel pattern in prices. When a price is in a channel pattern, lets say upward channel, it can bounce off each side as it moves up! We know the idea of a channel from river channels with meandering sides. Actually, the geometric equation showing the forces of the water moving against channel banks are exactly the same equations for a price channel.
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Using Google Trends to Predict Market Action
There are almost countless other examples of price and sentiment. But I want to show you something that is very exciting and never before available. Because of the internet, there is a completely new tool to use that gives us clues regarding market movements. I use this to gain insight into the darker forces of opinion that moves the market.
Google Trends provides data visualization on key words that appear as searches or on news references. This provides a finger on the “pulse” of “chatter.” If the frequency of occurrences increases, there is a surge in the level of awareness about a concept. The key is the rate of change in occurrences and not necessarily the level. Let’s look at charting of the words” US Deficit,” “inflation” and “deflation.”
What we see at once are spikes in their occurrences, and an almost cyclical nature. These patterns are not accidental. Awareness levels reflect concern and there are peaks and trough in regarding the emotions associated with the terms. Fear of US Deficit, and inflation are, according to the last patterns, in an upward cycle, while fear of deflation is at a bottoming out.
You can use these patterns in many ways and I use them to create further confirmation of my binary plays.
A good use for Google Trends is to confirm a directional decision based on fundamentals. If fear of US Deficit is increasing, then an appropriate bearish focus on the dollar is more appropriate as a strategy. If a spike occurs, such as the deflation occurrence spike in late 2008, expect that the spike will be temporary and be more careful in investments that anticipate a longer term effect.
The old adage that sticks and stones can break out bones, but words can never harm us, doesn’t apply to this new age of the globalization of attitudes.
Clearly fundamental analysis can no longer be a simple subset of economic analysis. Rather, it now must include real-time Internet chatter and word count frequencies. Words are the new charts, and we’d better learn to use them!
Sincerely,
Abe Cofnas
Currency Analyst for the Penny Sleuth
P.S.: Obviously, implementing a sentiment-sensitive strategy takes a lot of legwork. You need to watch indicators closely, and constantly interpret what specific sentiment levels suggest for a trade’s direction. It’s not for everyone. That’s why I came on as the editor of Strategic Currency Trader. It gives me an opportunity to share my research — and specific trades — with a small group of “in-the-know” readers. To learn how my “one week options” strategy works, click here…
Profit from New Methods of Visualizing Sentiment is featured at the Penny Sleuth.
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