How to use IG client sentiment
Alongside technical and fundamental analysis, IG’s sentiment data can be a useful additional tool for a trader, if they know how to read the changes in positioning.
Client sentiment, which looks at the number of long and short trades on a particular market, is a useful tool in a trading strategy. It is often said that clients look to sell into rising markets and buy into falling ones. There is an element of truth to this, but it is also important to look at turning points in sentiment, when the number of long positions begins to rise or fall. When combined with price analysis, the foundation of all good trading, a useful picture can emerge.
How to use client sentiment example
We can use an example to illustrate this. Below is the combined chart of GBP/JPY and client sentiment on this particular market:
This has been a volatile currency pair, with dramatic swings over the past few months. What stands out is that at the peak in early November 2018 clients were only around 35% net long (longs minus shorts). Clients had reduced their long positions and short positions had increased as the price rose from mid-October. Then, the sharp turnaround in the price, which began a steady downtrend, was accompanied by a steady rise in long positions, so that the net long figure rose to over 60%.
Indeed, long positions then rose in December to over 70%. However, when the price began to rise in early January, long positions decreased and short positions rose. While the attention of many is drawn to what happened as the price changed direction, the interesting element is actually the wide divergence on the chart between price and sentiment.
When the gap becomes this wide, then a reversal can be at hand. Similarly, we saw net long positions decline to below 30% in March of this year when the price hit highs around 148. The combination of a new high for the year and bearish client sentiment suggested a turning point was at hand. While downside has been limited so far, it was a sign that the steady rally from the January lows had come to an end for the time being.
A similar picture prevails in EUR/USD. The pair had been trending lower in the early months of 2019, and client sentiment as seen below was a good predictor of possible turning points. Clients were significantly net long at the lows of the downtrend, for example at $1.13 and then $1.125, and then short positions increased at the lower highs at $1.15 and $1.14.
Another very good example is that of the S&P 500. Clients were almost 70% net long at the lows in December, a very high level for indices which usually see low net long readings (ie net short). Sentiment returned to ‘normal’ from January onwards, with net long positions falling below 30%, but the small sell-off in early February saw this spike towards 35%.
The above examples should help to illustrate how to treat client sentiment. It is not enough merely to ‘do the opposite’ but look at the changes in sentiment and the direction of travel for sentiment as well as the price. For short-term traders, identifying these relative extremes in price versus sentiment can be a useful addition to a trading strategy.
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