It recently came to his attention that not many traders have used—or even heard of—the Speculative Sentiment Index or SSI, so Rob Pasche of DailyFX.com explains what it is and how to use it.
What is SSI? What is Retail Sentiment?
I won’t lie, forex trading is hard. Most traders that participate in the forex market lose money and, for the first couple years of my trading career, I was a part of that statistic. It was only when I began using the SSI that I started to see some positive results.
The SSI is an index released twice a day that gives us a comparison between how many FXCM traders are buying and selling each major currency. Each account is counted once, regardless of trade size. The result is a single number, positive or negative, that gives us trader sentiment. If SSI is positive, there are more buyers than sellers. If the SSI is negative, there are more sellers than buyers.
The actual number represents the number of traders trading in the more popular direction for every one trader that is trading in the less popular direction. For example:
If SSI is -5.67, there are 5.67 sellers for every 1 buyer.
If SSI is +3.02, there are 3.02 buyers for every 1 seller.
Learn Forex: SSI Statistics for Major Currency Pairs
(Created using DailyFX Plus’ SSI)
Click to Enlarge
These calculations are updated for each major currency pair twice a day inside DailyFX Plus, pictured above.
How Can the SSI Be Used?
So now that we understand how to read the SSI, how can this be used in our trading? It is actually very easy. We want to only take trades opposite of the SSI. So, if most people are buying a pair (SSI is positive), we only look for selling opportunities. If most people are selling a pair (SSI is negative), we only look for buying opportunities. SSI is what we call a “contrarian index.”
I’ve heard a lot of debate on why SSI should be used as a contrarian index, but my two favorite explanations are:
- Most retail traders lose money, so if we take the opposite side of their trades, we should have an edge.
- If most retail traders are trading in the same direction and price moves against them, they will have to cover their positions to stop their losses. This could cause a cascade of orders pushing price further against the crowd and hitting even more stops.
Regardless of the reasoning we use, there is no denying that price often times has an inverse relationship to SSI. In the USD/CAD SSI chart listed below, we see SSI drawn as red and green bars while USD/CAD’s price is drawn as a thin black line. Notice how price moves during times when SSI is negative and when SSI is positive.
We see price moving up when SSI is negative and price moving down when SSI is positive.
Learn Forex: Speculative Sentiment Index Effect on Price Direction
(Created using DailyFX Plus’ SSI)
Click to Enlarge
Understand that there will be times when SSI will get us into some bad trades. It is not the Holy Grail. But it can be used as effective direction filter for your strategy, whatever your strategy may be. It certainly has helped mine.
What Other Ways Can SSI Be Used?
There is more than one way to use SSI, which I do want to make sure I mention in this article.
The first alternate method of using SSI is the act of creating “Synthetic SSI.”
You might have noticed that not all 50+ currency pairs are listed. This is mainly due to low volume on many of the pairs, but there is a way to create a synthetic SSI value for popular currency crosses.
Another way to analyze SSI is one not too often talked about, analyzing the change in SSI rather than the raw SSI value itself. For example, if SSI for the EUR/USD is -4.50 and changes to -1.60 the next day, this is a huge change in sentiment. Even though sentiment is still showing more sellers than buyers (traditionally an SSI bias to buy), the massive shift could indicate we might look to sell the EUR/USD instead.
Studying the effects of change in SSI and price is a topic complex enough for its own article, something I intend to write up at a later date. But in the meantime, using SSI in the traditional manner is suitable in most cases. SSI will rarely move that quickly.
Sentiment, the Secret Weapon
Hopefully, this article has opened your eyes to the world of sentiment trading. Using SSI as a simple direction filter could turn a losing strategy into and winner, or increase the profitability of an already successful strategy.
By Rob Pasche, Trading Instructor, DailyFX.com
