Technical traders like to think technical analysis is the quantification of market sentiment, which consists of a hodgepodge of fundamental facts, consensus interpretation of those facts, reconceptions, misconceptions, prejudice and lies.
Such traders contend it’s not really worth untangling all these fundamental elements because price cuts through all the buzz and clutter, providing the only truth you need to make a trade.
However, traders should not dismiss the study of market fundamentals, because technical analysis alone doesn’t always work. If you’ve used technical indicators for any time at all, you’ve learned no indicator works 100 percent of the time — in fact, most work less than 50 percent of the time. That doesn’t mean you should discard indicators, but it does mean you should use multiple tools and money management techniques. Even then, however, you can still get blindsided by a change in market sentiment, which most indicators will confirm only with a lag.
What is the structure of market sentiment and how can you use it to make better technical trading decisions? Equally important, when should you pay the most attention to sentiment? Regarding timing, it’s never more important to supplement a trading decision with sentiment than when a market is consolidating. Prices are non trending well over half the time; some analysts put the figure as high as 70 percent. When prices are consolidating, we expect a breakout one way or the other, but it can be devilishly hard to select the right direction when some indicators are pointing up and others are pointing down. If you understand the components of market sentiment, however, you can judge their effect on the technicals, and often be better prepared to jump on the breakout.
Market sentiment is crucial during corrections, too. You never know when a correction will turn into a reversal. At the critical start and end points of a correction, it is almost always a sentiment change based on news that triggers the move. The market often seems to use some factor or another, real or imagined, to engineer a correction it wants.
Corrections are somehow part of the natural order of markets, so traders must invent excuses to exit positions, whether the story holds water or not.
It’s handy to know whether a corrective move is rational and valid, or just an excuse. Analyzing the fundamentals helps make such distinctions.
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