Sentiment

The more research you do on a market the smarter you will become about that market and understanding the background factors effecting your market will expose the overall Path of Least Resistance. The economy, the markets, business within a sector will follow the Path of Least Resistance and this path is based on expectations: expectations of where the economy is going and how that will affect particular markets.

Understanding the background of a market will greatly enhance your understanding long-term market direction and reduce the likelihood of surprises when trading. For instance, spotting a leading indicator of supply could mean that expectations are for an increase in demand and that demand will be fed at higher and higher prices, but if this expectation is out of line, the increased supply will cause a drop in price.

If you want to trade the markets, you should know how the markets work and what broad-market or outside influences effects them. The longer the time frame you trade the more influencial broad market fundamentals become. Even an awareness of macro economic theory or of the business cycles could be helpful when trading.
I’ve had this sentiment section in mind for a long time. Most everything I’ve read about the big successes have had something to say about the market background or broad market conditions. This is where I’m coming from:

In The Original Turtle Trading Rules, Curtis Faith described their method for adjusting their position size. The Turtles used a normalizing algorithm based on the dollar volitility of the market. This comes from an in-depth understanding of the market they were trading and this overview of the background market had specific applications to each commodity they traded.

Trading based on market Sentiment is what turnd Jesse Livermore around and made him famous. In Reminiscences:
I can’t tell you how it came to take me so many years to learn that instead of placing piking bets on what the next few quotations were going to be, my game was to anticipate what was going to happen in a big way.

Chartists miss or skip over critical phrases of Tom Williams’ in Master the Markets:
Volume Spread Analysis seeks to establish the cause of price movements, and from the cause, predict the future direction of prices. The ‘cause’ is quite simply the imbalance between Supply and Demand in the market, which is created by the activity of professional operators. The effect is either a bullish or bearish move according to the prevailing market conditions…

Your daily decisions are based on your background information and only partly on what is happening today. If you won the lottery last week, yes, you might be buying a yacht today, but your decision to buy a yacht today will be based on your recent background history of financial strength appearing in your life last week. The stock market is the same. Today’s action is heavily influenced by recent background strength or weakness, rather than what is actually happening today (this is why ‘news’ does not have a long-term effect). If the market is being artificially marked up, this will be due to weakness in the background. If prices are being artificially marked down, it will be due to strength in the background…

Strong holders are usually those traders who have not allowed themselves to be trapped into a poor trading situation. They are happy with their position, and they will not be shaken out on sudden down-moves, or sucked into the market at or near the top. Strong holders are strong because they are trading on the right side of the market…

This is what was eating at me and disappointed me when studying options, then gave me such great elation when studying bonds. When I hit on, and understood, the connection between interests rates, inflation and the yield curve it opened the door for me and I knew exactly what I wanted and how to get it. I’m surprised this isn’t covered more in VSA, but it is in the Wyckoff Method.
I will also expand the definition of Smart Money with more on fund managers and insitutions. They are well funded and smart, but they have different methods and priorities as to how they reach their goals.This will lead into the very intersting charateristic of Smart Money which is Money Flow.

Another inportant aspect of the broad market background is in risk awareness: is the economy moving toward risk appetite or risk aversion? Each will have ramifications in specific markets and sectors. For instance, depending on the degree, risk aversion will cause money to flow into safe havens or take a ‘flight to quality’.

Like chart indicators, you only need to master a few sentiment indicators, especially if you’re specializing in one stock, index, currency pair, etc. But I will try to cover enough on this topic that others interested in following this direction can develop the indicators for their specific market. I’ll use the top-down method and start with the Economic Cycle.