The statistical edge of trading against retail sentiment

I spent today analysing historical position data off OANDA. I wanted to know what sort of edge I can expect when trading against retail sentiment. If retail sentiment was extremely bullish, what sort of edge could I expect by selling short, and vice versa?

I analysed four currency pairs: the AUDUSD, AUDJPY, USDCAD and EURUSD. OANDA's data only went back one year, so that is the time scope I analysed. I then checked for days where retail sentiment was at least 65% bullish or bearish. Basically I was looking for extreme bullish or bearish sentiment. I then checked how much price moved during each of those days (from the close of the previous day to the close of the current day), and created a total. 

These are the results:

For each currency pair, if you traded with extreme retail sentiment (65%+ bullish or bearish), you would've lost pips (hence the negative value). If you traded against retail sentiment, you would've made pips. This analysis seems to confirm the idea of betting against the crowd. 

Hedging the carry trade

I'm still researching this idea. I was performing some research on different brokers to see who could provide the best overnight swap / rollover rate for my long USDHKD carry trade (you can compare broker swap rates here).

It turned out IC Markets was the best broker, which was very fortunate for me (I trade mainly via IC Markets already). 

I was also surprised to see that there were some brokers offering positive swap rates on the short side. 

Essentially, what you can do is buy 1 lot and collect interest with one broker (e.g. IC Markets) and sell 1 lot and collect interest with another broker (e.g. Hirose Financial UK). Both positions are hedged against one another, protecting you from losses, while you collect interest from both positions. 

Is this feasible? Other pairs also provide hedged carry-trade opportunities. For example, with the EURJPY, you can go long and collect 0.85 points per lot from OANDA,  and go short and collect 0.3 points per lot from Alpari NZ. 

I'll experiment with some demo accounts to see if this can really work. 

Alpari's Open Positions - retail sentiment tool

For anyone interested in taking a snapshot of retail sentiment, I found a better tool than OANDA's Open Positions book. It's Alpari's Open Positions book. Unlike OANDA, Alpari offers a snapshot of almost all the major and minor currency pairs, plus a few exotics.

HK central bank stance on the USDHKD peg

I spent tonight doing some fundamental analysis of the USDHKD. I'm not so much concerned about potential bullishness of the USDHKD as I am about the USDHKD peg itself. To me, the peg is of paramount importance, since it provides a near risk-free carry trade, regardless of the price moving up or down.

HK Central Bank policy and statements

The HK central bank (Hong Kong Monetary Authority) maintains its website here, where you can find its press releases and statements. 

The latest statement regarding the peg was released during October 2013. The head of the HKMA seemed ardent in defending the peg (the Linked Exchanged Rate System, aka LERS). 

We should bear in mind that the currency regime is the basic building block of all our economic and financial activities.  The monetary regime must be handled with utmost care and caution in order to preserve continuity and credibility.  Shifting from one regime to another carries enormous risks and may lead to disastrous outcomes.  Over the past three decades, Hong Kong’s LERS has worked well and proved to be effective.  The LERS has served as the cornerstone for Hong Kong's monetary and financial stability.  We acknowledge that it is not a perfect regime.  We have studied and evaluated many different alternatives, and have reached the conclusion that the LERS is still the most appropriate regime for Hong Kong.  This is the same conclusion shared by the International Monetary Fund.  Lastly, let me reaffirm that for the reasons set out above, there is neither the need nor the intention to change the LERS.

The emboldened sentences seem to be particularly aimed at speculators. 

There is also a FAQ in pdf format. 

Update on USDHKD carry trade

Looks like speculators attacked 7.75000 yesterday. On the daily chart, we can see a pinbar and rejection off 7.75000 as the HK central bank intervened to defend that level.

If we zoom in to the 15M chart, we can see where speculators dumped a whole lot of USDHKD within a tiny time frame. I checked the data feed on two different brokers (IC Markets and Pepperstone) and both showed the same price action.

With price hovering close to 7.75000, I used the opportunity to double my carry trade position. My risk is about 5%-6% of my equity.

OANDA's Historical Position Ratios

I found this interesting tool at OANDA - Forex Historical Position Ratios. If you want to see evidence of retail traders mostly losing money, you can see it here.

The graph above shows historical position ratios for the EURJPY over the last year.

As you can see, retail traders stubbornly remained short (over 50% of positions) as the EURJPY rose from 133 to 145 during late 2013 / early 2014. That's alot of bleeding. Once price peaked at 145, retail traders continued to add to their longs, meaning they bought at the peak.  In the last month, as the EURJPY fell, you can see retail long positions continuing to climb while shorts evaporate.

You can get a snapshot of current open positions here. As of this moment:

Retail traders are overwhelming bullish on the EURCHF and silver (XAGUSD). Conversely, they seem very bearish on the GBPUSD. It's possible to use this information as a contrarian indicator. In this case, the institutional money (strong holders) may realise that retail traders (weak holders) are overwhelmingly long on silver, and decide to shake retail longs by driving price down. When retail longs exit their positions by selling, they add even more downward pressure to silver's price. It might be prudent to look for short entries in this case.