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Forex Sentiment Analysis

December 10th, 2018 @ 5:32 pm by Muhammad Azeem

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Forex Sentiment Analysis

When trading within the forex market, there are three key methods of analysis which can be used to identify possible trends and ultimately decide our positions within the market. These are, fundamental analysis, technical analysis, and sentiment analysis. Of these methods, the most nuanced and challenging to interpret is sentiment analysis. In the fast-paced world of online trading, it is of key importance to understand both the key sentiment indicators and how to react to them appropriately when trading forex.

What is Sentiment Analysis in the Forex Market?

For good reason, sentiment analysis has been employed by almost all of the most successful forex traders to a high degree. It is notoriously difficult to measure, but at its core, sentiment analysis is the study of how the forex market feels at a particular time. Essentially, when we engage in forex market trading, we are expressing our feeling related to how a particular currency pair might perform. Zooming out from our singular decision allows us to see that every combined action within the market forms a general “feeling”. This is the market sentiment.

Through analysis of this sentiment and how it may be impacted by certain trading factors, we can establish how the market will react and thus position our trades accordingly. Being aware of how the market feels, ultimately allows traders to effectively leverage the market sentiment, trading in the direction which they feel the market will take based on a few of the key indicators.

Sentiment analysis also gives rise to another class of trader. That is the contrarian trader. This is someone, whether forex trading online or otherwise, likes to trade against the prevailing market sentiment. Eduardo Elsztain and George Soros are both prime examples of famous traders who profited largely from going against market sentiment.

Key Sentiment Indicators and How to Interpret Them

Sentiment indicators play a vital role in helping traders gauge the current sentiment of the market. These are something which many new traders should be made aware of early on through any reputable forex trading tutorial. Tradefw.com is a positive example of a forex trading broker who offers such an in-depth educational program.

Commitment of Traders Reports

The Commitment of Traders (COT) report is one of the most valuable ways in which you can get an accurate feel for the forex market sentiment, quantified through the featured data. The report is published by the Commodity Futures Trading Commission each Friday and shows the open positions as of the preceding Tuesday.

The data featured in a COT, although not in real time, is the most accurate to represent the market status. In interpretation of this data, traders should be checking for extreme positions within the market. The following formula can be used to extract that percentage from the data:

Commitment of Traders Reports

Volatility Index (VIX)

A second quite effective method for gauging sentiment within the forex market is by viewing the Volatility Index published by the Chicago Board Options Exchange. Generally speaking, since market sentiment is largely based on the emotion and feeling of the market as a whole, the more volatile a currency is rated by the CBOE, the more fear is existing. This would typically create negative forex sentiment trading around that currency.

Market Volume Indicators

Volume indicators as a link to forex market sentiment are especially important. This includes the likes of the Money Flow Index (MFI), and the On-Balance Volume (OBV). The MFI is used to chart the money flow into the market over several days, with an obviously increased flow being linked to market confidence and correlating positive sentiment.

The OBV is also used to chart buying and selling pressure within the market, a key measurement when it comes to correctly identifying the market sentiment.

Independent Broker Tools

Due to the decentralized nature of the forex industry, it can be quite difficult to get precise data on exact positions and volumes within the industry, as they do not all pass through one centralized point. For that reason, many forex brokers will offer their own tools to assist with your sentiment analysis. These can and should then be cross-checked through other forex trading platforms.

The Importance of Sentiment Analysis

Within forex trading and any market, technical, fundamental, and sentiment analysis are all important aspects. Separately, these can identify certain patterns which can help direct your trading in a positive manner, or steer it away from dangerous situations in certain instances. When combined however, these can form a detailed analytical picture of the forex market which will vastly help in improving your skills as a forex trader.

Trading forex without conducting sentiment analysis decreases the amount of knowledge a trader has at their disposal. Ultimately, this results in a higher level of risk when trading in any market.

Conclusion

Although difficult to pinpoint with extreme accuracy due to its inherently emotional nature, sentiment analysis will form a key part of your forex trading strategy alongside the other forms of analysis. The value in this analysis is clear to see and should not be discounted. Having been used by some of the most prolific traders in the forex market over time, its effectiveness has been all but proven.

For this reason, it is imperative to choose a reliable forex broker who will guide you on the journey to understanding sentiment analysis in detail and provide support in other areas of your forex trading progression.

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