Differential Effects of Buy and Sell Rules in Sentiment-Informed EUR/USD Trading

Abstract

Sentiment indicators are often appealing to investors since financial markets are known to be influenced not only by economic fundamentals but also by emotions (Shiller & Akerlof, 2009). In current studies, however, a range of alternative sentiment indices is used each of which purports to have predictive value for the movements in financial markets. Consequently, a question mark remains in regards to the comparability of findings across different research papers. The goal of this study is to address the question of choice between competing sentiment indicators in EUR/USD trading. To identify the indicator having the best predictive value we estimate expected returns for individual sources and forecast models via backtesting (Campbell, 2005). Our findings support the notion that the predictive value depends on the source of the sentiment-indicator, on timing aspects, with more recent sentiments having greater predictive strength, and on the type of rule (e.g., buy/sell) harnessed.