Im sure you have all seen adverts online for CFD and spread betting brokers. They are everywhere at the moment and there is a reason for that… retail traders are easy money for them. But why?
Retail traders always lose in the long run!* If you look closely at the adverts you will see that they all state the percentage of traders losing money that use their broker to trade. This is thanks to the new ESMA regulations that mean the brokers now have to disclose this information on all marketing materials. Most of the brokers show figures of over 70% with some as high as 86% of retail traders losing money with them. See it for yourself below.
*Disclaimer – By this I mean that the majority of retail traders lose money. Therefore it can be assumed that as a group, more retail traders lose money than make money and therefore retail traders, as a group, lose in the long tun.
So what does this have to do with trading sentiment and using this to help with your analysis? Well, put simply… if 86% of retail traders are losing money there is a very good chance of making money by doing the very opposite of what they are doing. If the majority of retail traders lose and you can see how these retail traders are betting on an FX currency, Commodity or Index it would make reasonable sense to do the opposite.
Some of you are probably now thinking that you have found the secret “holy grail” to trading success and you are ready to start making millions but I will stop you there. On it’s own, retail trading sentiment will not make you a successful trader but by using it in conjunction with other technical and fundamental analysis you should be able to improve your overall trading profitability.
I have also found that sentiment data for financial instruments like Gold and the S&P500 has less of a profound effect as they tend to be more influenced by “flock mentality”. What I mean by that is that following the majority tends to work better on those instruments and this is probably down to less speculative trading and a more traditional investing approach being taken by all types of traders.
I do encourage you all to go and find the sentiment data and backtest it/try it out for yourself. You might find something I haven’t noticed with other financial instruments.
Where do I find the data?
A number of brokers publish the trading sentiment data of their retail trading clients but the one I use is found over at the DailyFX website. In my opinion, it is the easiest to use and it comes directly from the IG broker who is one of the largest CFD brokers out there. A link to their trading sentiment data can be found on my helpful trading tools page.
What is it?
The trading sentiment data you can see above is the long & short positions of retail traders using the IG broker platform, shown as a percentage. So you can see the directional bias of retail traders based on a specific FX currency, commodity or index. You can also see the directional change from the previous week and the change on open.
Another reason why I like to use the DailyFX website is that they also present the data in a chart with market price history. You can then see how the relationship between trader sentiment and price interacts and correlates.
What does it mean?
Let’s look at the USD/JPY FX currency pair as an example and I will talk you through what it all means.
Essentially, as at today 46% retail traders trading USDJPY on the IG brokerage are holding short positions on the FX pair. So that means the majority, 54% of traders, who are trading USDJPY are holding long positions.
We also know that the number of traders holding long positions on USDJPY has been increasing since last week and therefore the number of retail traders holding short positions has decreased.
The MAJORITY of retail traders are betting LONG on the USDJPY FX currency pair. And look at what has happened to price…. It has dropped.
How to use it when trading.
So, before I explain how you could use this retail trader sentiment data in your analysis let’s look at the chart above. Can you see anything blindingly obvious about it?…
Can you see it?
Yeah you got it! (I hope). There is an inverse relationship between price and the net long/short holdings of retail traders trading that instrument. The correlation isn’t perfect but it is very evident and easily noticeable from simply looking at the chart. This further backs up the data that says between 70-80% of retail traders lose money when trading the financial markets. Let’s look at the chart in detail.
The easiest times to see where retail traders would have been squeezed out of the markets or pushed in to drawdown is when price crosses the net long/short line and the correlation swaps. If you look at the chart just after the 17th December 2018 there is a prime example of this. Price drops from around 113.70 to 111.00 and price crosses the net long/short line but at the same time, the majority of retail traders are going increasingly net long on this FX currency pair. On the 27th December 2018 the number of traders net long on USDJPY was over 60% and look at what happened. Price continued to drop and the next day even more retail traders trading USDJPY on the IG brokerage went long.
Price then dropped dramatically over the next 2 days and I imagine a lot of retail traders lost a lot of money. Many would have been squeezed out of their long positions and stop losses hit. You can see this is the case because almost immediately the net long/short ratio begins to reverse just as price does. Price had found its support and retail traders had run out of funds, buying power and bravado.
This process happens again and again throughout time and you can see it for yourselves by going to the DailyFX website and looking at the retail trading sentiment data.
If you use trading sentiment in conjunction with your other analysis like trendlines, resistance levels and patterns then you should hopefully avoid being one of the many that get squeezed out of the markets. Look at what is happening to the trading sentiment, where it has been and where it is going to in relation to price. It is just as important to note the change in trader sentiment as it is knowing the current net long/short bias.
Finally, you must know that this is not an exact science and there are a few key things to remember when using this data in your analysis.
Firstly, you are only using the trading sentiment data of one broker and although they may be one of the largest brokers, the combined clients of all other brokers is much greater. That being said, retail traders and especially new and inexperience retail traders tend to think the same. Secondly, there will always be occasions when the majority of retail traders will be correct in their analysis and will be on the right side of trades. That is life and that is the nature of the markets… if enough people want to buy something then the simply laws of supply & demand will cause price to increase.
My main purpose of writing this post was to show you that the “game” of CFD trading is dangerous and you can see this by looking at the % of losing accounts in the first image of this post. I also wanted to show you that you can use these negative odds of success to your advantage and if done correctly, further improve the quality of your analysis and try to get out of the statistics and become the minority. You can become part of the 14% that don’t lose money in the long term.
Happy Friday everyone! I hope you enjoyed this post and that some if not all of you have learnt something new 🙂