Intermediate Level

Learn more complex tools and techniques that will help you in trading.

Lesson 7: Sentiment Analysis

Forex
sentiment analysis can be a valuable tool to help investors understand and act
on market behavior. While the application of sound technical and fundamental
analyzes is important, an additional sense of market consensus that add depth
to the Forex and other market views of traders. In this post, we explain what
market sentiment is, how it applies to Forex trading, and what the top
sentiment indicators are.

What is Market Sentiment?

Market
sentiment describes how investors feel about a specific market or financial
instrument. As investors, sentiment becomes more optimistic as the overall
market opinion becomes more positive. Likewise, when market participants start
to have a negative attitude, sentiment may become negative.

As such,
investors use sentiment analysis to describe a market as bullish and bearish,
with a bear market marked by assets dropping, and a bull market with prices
rising. Traders can gauge market sentiment by using a variety of tools, such as
sentiment indicators (see below), or simply by watching market movements, using
the resulting information to make their decisions.

What is Sentiment Analysis in Forex
Trading?

Sentiment
analysis can be directly translated into currency pairs, even though it is not
special to the Forex market. Contrarian traders will be searching for crowds to
either buy or sell a similar currency pair while waiting to take a position in
the opposite direction of sentiment.

How Forex Sentiment Analysis Works

An example
of how sentiment analysis can be applied in Forex trading is a large single
spike in GBP/USD in 2016, with a negative feeling that GBP is slumping to a
31-year low following Britain’s vote to leave the European Union. After a
generally positive mood in the following year, a negative feeling took over
much of 2018 until prices began to rise in 2019.

Another
example of a net short-term bias can be seen in the EUR / GBP graph below, with
21.9 percent of net investors, with a short-to long-trade ratio of 3.58 to 1.
The graph shows in blue the percentage of IG traders taking a net long position
and in red the percentage taking a net short position.

Net
Negative Sentiment Analysis alongside Price Action

Increasing
sentiment that mean that few traders are left to keep up the trend. In this
situation, traders may want to pay attention to a price reversal. On the other
hand, a lower price, showing signs that it has exceeded, can lead a trader to
feel short. The graph below shows an example of the EUR/USD pair having a
positive net feeling.

Positive
Sentiment Analysis alongside price action

Using Sentiment Indicators

Sentiment
indicators are statistical or visual representations of how bullish or negative
traders are about market conditions. This may apply to the percentage of trades
that have taken a given position in a currency pair. For example, 70 percent of
traders going long and 30 percent going short would simply mean that 70 percent
of traders are long on a currency pair.

The best
sentiment measures for Forex traders include the IG Client Sentiment (as shown
in the above charts) and the Commitment of Traders (COT) survey.

IG Client Sentiment

IG Client Sentiment (linked) may be a useful tool to
integrate into your trading strategy. It can provide a useful picture of the
number of long and short trades taking place in a particular market, giving the
impression of turning points in sentiment. For another good sentiment indicator
(Forex Factory), please click here.

Commitments of Traders Report

The Commitment of Traders
(COC) Report, released daily by the Commodity Futures Trading Commission
(CFTC), is compiled from submissions made by traders in commodity markets,
providing a description of the obligations of listed trading groups. The CFTC
report is released every Friday at 15:30 Eastern Time and may be a valuable
market warning.