What are Sentiment Indicators?

Understanding Sentiment Indicators

Sentiment indicators track how optimistic or pessimistic traders and investors are toward a market. They help answer the question: “Who is positioned where, and could a reversal occur if they’re wrong?” Popular tools include the Commitment of Traders (COT) report, broker retail-positioning dashboards, options skew, and volatility indices such as the VIX.

Key Sentiment Gauges

• COT Report: Weekly data from the CFTC showing futures positioning among commercials, large speculators, and leveraged funds.
• Retail sentiment: Broker data revealing the percentage of clients long versus short a pair—useful as a contrarian indicator.
• Options market: Risk reversals and implied-volatility skews indicate how professionals are hedging directional risk.
• Surveys and indices: AAII sentiment, ZEW, or business surveys highlighting investor mood across asset classes.

How Traders Apply Sentiment

Extremes in positioning can foreshadow sharp reversals when crowded trades unwind. Use sentiment as context—if EUR/USD approaches resistance while COT shows record-long speculative positioning, be cautious chasing higher. Conversely, if retail traders are heavily short but price keeps rising, the trend may still have room as shorts capitulate.

Limitations

Sentiment indicators often lag and may not capture rapid shifts after major news. Retail data represents only a slice of the market, and speculative positioning can stay extreme during strong trends. Treat sentiment as a supplementary lens—not a stand-alone trigger—and maintain disciplined risk management.

Advanced Guidance

Build a repeatable, rules‑based process so decisions are consistent across sessions and instruments. Start from context (higher‑timeframe structure, positioning, macro tone), then define precise triggers and invalidation on execution charts. Track spread and depth so your order type matches conditions. Pre‑compute scenarios (breakout, fakeout, mean‑revert) and map actions for each to reduce hesitation.

Execution Framework

• Plan entries at levels with confluence (structure, momentum, time‑of‑day).
• Place stops beyond the logical invalidation, not arbitrary distances.
• Target at least 2–3R; scale out methodically and trail remainder.
• Avoid thin liquidity windows unless the setup explicitly requires it.
• Record slippage and spreads; poor fills can erase edge.

Review Loop

• Journal setups by session and pair to learn where they excel.
• Tag trades by catalyst (news, trend continuation, range breakout).
• Recalculate expectancy monthly; prune underperforming variants.

Risk Controls

Keep daily loss limits, reduce size after consecutive losses, and pause during regime shifts. Survival enables compounding; treat discipline and execution quality as part of your edge.