And that is sentiment analysis. Among the countless factors and criteria that you need to be on the lookout for in the Forex market, there is something that stands out from others.
And it is easy to see why this form of market analysis stands out from other forms with similar intention. This is because while other factors that we usually take into account with respect to influential factors in the market, sentiment analysis seems to be the least scientific and objective form. But is it? Not quite as it turns out.
To find out more about sentiment analysis and its tools in the foreign exchange market, keep reading this article as we will tackle this question in detail and in depth.
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What Exactly Is Sentiment Analysis?
When you want to approach a problem, any problem, the most fundamental question to ask at the very beginning is from which direction or perspective you should approach the problem. That is exactly what sets you up for ultimate success or failure.
The same principle is true in the financial markets. If we consider market analysis as the problem that ought to be figured out and solved in a way, then there are many different approaches to take and many different perspectives from which you can tackle the issue.
There are different methods of analysis that consider different factors to be the most important; such as fundamental economic factors like GPD, unemployment rates, or the smallest price movements and fluctuations in a small time frame. But there is another factor, as is the subject of this article, that forms the basis of the analysis type we are discussing now. And that is sentiment.
In sentiment analysis, which just happens to be one of the most conventional and one of the oldest market analysis methods across all financial markets, the sentiment of the participants in that market is considered as the most important factor for analysis and predicting the future of the market.
The roots of sentiment analysis go back to the tradition of the Japanese merchants who noticed that they could predict market movements by analyzing the sentiment of people and participants in their own trade circle. That is also why some of the tools that are used for sentiment analysis have been developed by Japanese traders and market analysts.
So who are the market participants in the forex market? The traders of course.
As a result, with respect to sentiment analysis, the way traders feel in the forex market is the most important and influential factor in the outcome of market movements.
Now that we have a grasp on the meaning of sentiment analysis and where it comes from, it is time to take a look at how this form of analysis actually works, especially in the forex market.
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How Does Sentiment Analysis Work?
Can the sentiment of traders actually move the prices in the market? Let’s see how.
In this form of analysis, which is sentiment analysis, we are talking about the sentiment of the market participants in whatever market they might be. In the case of the forex market, we have of course traders.
Then this means the way traders in Forex feel can drive this market. For instance, if the majority of traders are overtaken by positive feelings about the future of a certain trading pair in the forex market and decide to all buy it, then this means a great majority of the traders for that pair are going long on it. When enough people go long on a specific trading pair, then it is only natural that we see that pair gaining in value and price.
The reverse is just true as well. If enough traders decide to sell a certain pair because they have become overwhelmed by feelings of fear and anxiety about the future price movements for that pair, then it means a great number of traders will go short. What happens afterwards is that the pair will eventually begin losing value because so many people are shorting it.
Such movements on the part of traders are seen many times, especially when the sentiment is too strong and there is a sudden price change in the form of reversal or breakouts in many different markets, including the forex market.
In order to avoid the negative aspect of sentiment analysis and be able to reap the benefits of this approach, then you need to be familiar with the tools that are associated with it and that is exactly what we will discuss in the next section.
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What Are Some Tools for Sentiment Analysis?
In order to be able to get the best out of sentiment analysis, then you need to know the right tools and methods to implement. There are two major approaches to use sentiment analysis:
- You can use indicators that can help you attain results that are relevant to sentiment analysis. There are of course many indicators that can help you with just that. But one group of indicators that are quite practical in this regard are volume indicators. Market volume can show you where the most interest of traders can be found. And where traders show the most interest is where they are taken by their emotions.
- Another useful approach for sentiment analysis is to use reports such as the COT report which stands for commitment of traders. This report is released on a weekly basis. And the most important feature of this report is that it precisely shows you the number of traders who have taken a long or a short position in the market with regard to different assets and trading pairs. In this way you can see, for instance, if the majority of traders are going long on a pair such as JPY/USD or going short. As it so happens, at the time of writing this article, 90% of traders in the forex market are going long on this pair. This clearly shows that traders feel positively about this pair and the Japanese Yen in particular.
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Conclusion
Sentiment analysis is a forex of market analysis in which the sentiment or feelings of traders are taken to be the most important factors for market analysis and making predictions. In this article we discussed sentiment analysis and the relevant tools that can be useful.
