The greater the proportion of long positions, the more positive the market sentiment on that particular currency.Experienced traders often treat market sentiment as a contrary indicator. Some traders will fight the crowd, and buy and sell against the prevailing trend in sentiment. For example, when the COT report indicates extreme positioning of the market, or when the market seems to be feeding off false euphoria on worse than expected news, it may be better to trade against the overall sentiment.You should, however, wait for a more precise signal that the current sentiment is wearing off before going against it, as sometimes false euphoria can last for quite some time before resulting in a reversal.
Both the biggest institutional traders and the smartest individual traders see where the "dumb money" goes. Most sentiment indicators look outside the price dynamics of a particular security or index of securities for information about whether the trading crowd is humming along with expectations […] However, these ways of getting a feel of the current market sentiment are not too accurate; you may think that other traders are in a buying or selling mood, but that may not be what is really happening in reality.
You can gauge market sentiment by the open interest in the currency, which is reported each week in the Commitment of Traders report issued weekly by the U.S. Commodities Futures Trading Commission.
The time lag between reporting and release is the main handicap of the COT data, but despite this limitation, you can still use it as a sentiment tool.The reason behind this is that these large speculators trade the futures contractsmainly for profits, and do not have the intention to take delivery of the underlying asset, which in this case would be cash.On the other hand, commercial participants tend to maintain and roll over the same amount of contracts from month to month for hedging purposes even though these positions could be in losses. Forex traders play the up-and-down swings in major currencies, such as the Japanese yen, the British pound, the euro, and the U.S. buck. Knowing whether this category has been net long or short a few days ago only indicates to us the positioning in retrospect; this information is only useful if you compare the latest net positioning with the positioning figures from the past few weeks or months.By comparing the latest net positioning with that of the past few weeks or months, you can tell if the latest net long or net short positioning is skewing towards an extreme reading.My observation of the financial markets is that dramatic price moves, usually at major turning points, tend to occur when the majority of the market is positioned incorrectly. Forex is as susceptible to market sentiment. You can go long or short, meaning you can bet on a rise or a fall, respectively, in the price of each currency pair.Major forex brokers keep track of long and short interest in each currency pair, with "interest" meaning the number of open trades for either position.