The Role of Short-term Sentiment in Trading

Introduction: Why sentiment is a key factor in trading

Price movements aren’t just about indicators like the RSI, MACD, or candle stick patterns, they’re also driven by human emotion. When traders become extremely optimistic, they tend to buy aggressively, often pushing prices higher in a short period. However, once this excitement fades, the market frequently corrects. Similarly, on the other extreme, when fear takes over and sentiment turns extremely negative, most short-term traders are sidelined. They are too scared to enter the markets. Ironically, this is often when markets start recovering. There is a very simple market mechanic at work here — when traders are afraid they sell, leaving more money on the sidelines to potentially enter the markets again. When traders are too optimistic, most money has been positioned, leaving the market with more potential sellers. 

By understanding these emotional cycles, traders can avoid reacting on emotions like FOMO (fear of missing out) and panic selling, leading to better decision-making. Instead of reacting in an emotional way to the markets, traders try to understand the sentiment and use it to their advantage. 

The psychology behind market sentiment