What is Sentiment Analysis?

Sentiment analysis is used to gauge how other traders feel, whether it’s about the overall currency market or about a particular currency pair. Earlier, we said that price action should theoretically reflect all available market information. Unfortunately for us forex traders, it isn’t that simple. The forex markets do not simply reflect all of the information out there because traders will all just act the same way. Of course, that isn’t how things work.

This is why sentiment analysis is important. Each trader has his or her own opinion of why the market is acting the way it does and whether to trade in the same direction of the market or against it.The market is just like Facebook – it’s a complex network made up of individuals who want to spam our news feeds. Kidding aside, the market basically represents what all traders – you, Warren Buffet, or Celine from the donut shop – feel about the market. Each trader’s thoughts and opinions, which are expressed through whatever position they take, helps form the overall sentiment of the market regardless of what information is out there. The problem is that as retail traders, no matter how strongly you feel about a certain trade, you can’t move the forex markets in your favor.Even if you truly believe that the dollar is going to go up, but everyone else is bearish on it, there’s nothing much you can do about it (unless you’re one of the GSs – George Soros or Goldman Sachs!). As a trader, you have to take all this into consideration. You need to perform sentiment analysis. It’s up to you to gauge how the market is feeling, whether it is bullish or bearish.

• Sentiment is a measure of how traders and investors view the outlook for the market and larger economy.
• Forex traders can use technical sentiment indicators to help identify entry and exit points for currency pair trades.
• These include COT reports, open interest, and brokers’ position summaries.

WHAT IS SENTIMENT ANALYSIS IN FOREX TRADING?

Forex sentiment analysis is the process of identifying the positioning of traders, whether net long or net short, to influence your own trading decisions in the currency market. While sentiment analysis can be directly translated to forex, it is also used for stocks and other assets. Contrarian investors will look for crowds to either buy or sell a specific currency pair, while waiting to take a position in the opposite direction of sentiment.

How Sentiment Indicators Work

Sentiment indicators show the percentage, or raw data, of how many trades or traders have taken a particular position in a currency pair. For example, assume there are 100 traders trading a currency pair; if 60 of them are long and 40 are short, then 60% of traders are long on the currency pair.

When the percentage of trades or traders in one position reaches an extreme level, sentiment indicators become very useful. Assume our aforementioned currency pair continues to rise, and eventually, 90 of the 100 traders are long (10 are short); there are very few traders left to keep pushing the trend up. Sentiment indicates it is time to begin watching for a price reversal. When the price moves lower and shows a signal it has topped, the sentiment trader enters short, assuming that those who are long will need to sell in order to avoid further losses as the price falls.

Sentiment indicators are not exact buy or sell signals. Wait for the price to confirm the reversal before acting on sentiment signals. Currencies can stay at extreme levels for long periods of time, and a reversal may not materialize immediately.