In Forex markets, like any other free market, prices are determined by the relationship between supply and demand – these, in turn, are determined by the market sentiment. After all, you are not alone in Forex markets, nor are you acting in some sort of vacuum. Quite the contrary, everything you do has an impact (albeit a minuscule one) on the other traders and vice versa: everything they do impacts you, in one way or another. If everybody starts taking the same positions on a currency pair, this will undoubtedly affect its value in a meaningful way. It will also determine the duration of such a state, because it will eventually return to normal as Forex traders make their profits and move on.
Market sentiment indicators
Sentiment indicators in Forex markets indicate the market sentiment towards a particular currency pair: how popular it is, how many traders in the Forex market have taken that particular position on that particular pair (in terms of percentage rather than an exact number) etc. When enough people starts doing the same thing, you have yourself a trend. And you can make money on trends, especially in Forex markets. Forex traders usually use Forex market sentiment indicators in conjunction with Forex fundamental analysis in order to maximize their chances of success.
Why are they important?
They become more and more practical as the market sentiment reaches extreme levels. As you probably know by this point, no trend can continue indefinitely, without an interruption and it eventually reverses. Market sentiment indicators can indicate how close a trend is to reversal, as there are only so many people who could participate and inflate the bubble further, before it bursts. If you manage to go short at the critical point, you will reap maximum profit that Forex trends could possibly have to offer (or at least that particular trend). However, if you wait too long or go prematurely, your profits take a cut or you could even take a loss (although this would be an extremely rare turn of events, diminished profits are far more likely unless you mess up big time).
Downside
In the interest of full disclosure, Forex market sentiment is a fickle thing, and no indicator can be 100% accurate. This problem can be addressed with a sound fundamental analysis, but this is by no means a permanent solution. It merely reduces the flaws of current indicators until something better comes along. Also, keep in mind you are not the only one with access to these, and there are probably many others waiting for the same thing as you. Finding the right time to execute your move is a form of art.
To conclude
Forex market sentiment is what drives supply and demand, effectively reigning supreme over the events that transpire as well as the consequences for the traders. No single trader, no matter how powerful, cannot control it, but every single trader, even the smallest one, can influence it to a point.