In the FOREX market there is never a reflection of all the information that it contains, because not all traders are going to act in the same way depending on the information.
What is a sentiment?
The sentiment is just a signal that indicates the possible direction of the price movement of an asset.
It’s about spotting some traders positions, to ultimately be able to understand the way that they think, and being capable of taking an advantage from it.
Now, it is necessary to know what the FOREX sentiment analysis is.
It is nothing more than the large feeling that the market participants have about the performance of a currency pair.
Another good definition is that the sentiment analysis is a process of assessing the undertone of a financial market; that is, through the study of recent and old information about a particular asset.
The sentiment analysis is also called ‘opinion mining’.
This is becoming an useful way of gauging the feeling or tone of the FOREX market and this way the trader can make appropriate decisions that can be applied on its trading strategy.
Why the sentiment analysis is so important in the FOREX market?
If you know how to give to the sentiment analysis a correct and proper use, then you can have this as an amazing tool to be a better trader. This one is a significant and important part of what drives movements in this so called FOREX market.
Let me give you a simple example; if 80 traders have placed buy orders on the GBP/USD and other 10 traders have placed sell orders on the currency pair, it shows the sentiment to be 80% overall in favor of buy positions.
Sometimes, if the trader has a positive attitude on a currency pair, the sentiment can be positive too. But, if the attitude is poor, then the sentiment has a high probability for it to be negative.
How to measure the sentiment analysis?
It is necessary to categorise the mood of the market participants, then, it is vital to determine the data sources. You need a data collector and work on a keyword list.
FOREX sentiment tools
In the FOREX market, the traders can find two common tools that are used to measure the market sentiment and make its analysis.
First of all, we have the contrarian indicators.
This strategy involves the fact of placing every order that can be against the actual market sentiment.
The traders that use the contrarian indicators place the long orders when they find a weak currency, and then, place the long orders when they find a strong currency.
These traders basically just take advantage of certain situations, especially when the market is in a specific level of saturation. For example, if the market is going through a selling spree, it is going to present opportunities to buy at a specific lower price, which will bring benefits to the trader.
More than a few technical contrarian indicators are available for gauging the market sentiment. A great example is the RSI (Relative Strength Index).
Now, the other tool is the commitment of traders report.
Commitment of traders report
The COT is provided by the CFTC (Commodity futures trading commission) every single Friday.
This sentiment tool is based on the net long and the shorts positions that were held by traders in the Chicago IMM exchange.
We know that the report doesn´t happen in real time, but still, the data is truly valuable to assist Forex traders that want to use it for gauging the current market sentiment and taking intermediate and some long term positions.
You can use the commitment of trader’s reports to trade. For example, one of the easiest ways of doing it is by identifying extreme net long positions or extreme net shorts positions.
Once you spot these positions, it is a fact that you will very soon see the weakening of the prevailing trend, and that will bring an imminent market reversal as a consequence.
You can use an indicator to interpret the commitment of traders report if you want to use it to trade. This report has three lines, a blue one, a green one, and the red.
The sentiment analysis is really important, because every single one of the traders have their own opinion of why the market is acting the way that is acting at that moment, and if it is profitable to trade in the same direction of the market is doing it, or if they should do it against it.
This is just an incredible and powerful technique that you can combine with other types of analysis, like the fundamental analysis or the technical analysis.
This is going to provide more profitable trading opportunities to the trader.