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I often write about market sentiment – how people are feeling about current market action and trends. It’s important to be aware of how you’re feeling about the markets, of course, but especially how others are feeling. By tracking both, you’ll know how to trade using sentiment.

What to notice about your own sentiment

Beware of your own sentiment in either direction – positive or negative. It can lead to complacency and costly trading mistakes.

Long bullish runs offer plenty of opportunities to make money. As winning trades stack up, traders can become giddy, believing they can do no wrong. Because bull markets move slowly and steadily up and to the right, traders eventually get very comfortable.

Getting comfortable isn’t a good thing – at least when it comes to trading. The more comfortable you are, the more complacent you become, and the less fear you have of making a mistake. You feel invincible and able to handle any obstacle that comes your way.

That lack of fear will cost you money every single time. Oh, it may not strike right away, but the more time goes on without an event that strikes fear in your gut, the less you believe markets won’t go down. This is not the time to take risks! Play it safe, and sell when you have profits.

As we all know, markets do go down – or at least not up forever. When they move sideways, or drop swiftly due to a short-term correction or longer-term bearish trend, traders become complacent in a different way. You may feel stuck, unable to make a trade. Well, you can trade a bear market, as scary as that sounds. It’s all about adjusting your strategy.

Measure your sentiment by assessing your current risk management strategy.

You might think you’re taking current market conditions in stride. You’re not giddy, but you’re also not bogged down by inertia. Since we aren’t the best judges of our behavior, assess how much risk you’re taking with your trades right now.

If you are feeling very confident, you may be risking more capital on each trade you place. If fear of losing is nagging at you, you may be making much smaller trades – or none at all. Adjust your trading strategy accordingly.

How to trade based on overall sentiment

What about everyone else’s sentiment? Extremes in overall sentiment send a signal that it’s time to take a contrarian stance.

If the boat is full of bulls or bears – with more piling in – it’s going to sink at some point. This is when you should be looking in the opposite direction for trades.

Too many bulls on board leaves one question: If everyone is long, who is left to buy?

If the boat gets too loaded with bears, just wait – bargain hunters will show up and start scooping up deals.

In these situations, it will pay to be a contrarian – and go against the pervading market sentiment. Everyone’s buying? Time to sell. Everyone’s selling? Time to buy.

Is this easy to do? No. Will your portfolio thank you? Yes.

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