Sentiment analysis for Forex trading: The Basics

Sentiment analysis for Forex trading: The Basics

If placing successful orders is one of your main focuses as a trader, correctly identifying the trends is an absolute necessity. Forex demands a thorough and detail-oriented approach to the current market situation analysis. Traders usually utilize technical and fundamental analysis when trading. These types of analyses make the perfect balance between making individual trading decisions and being well informed about the ongoing affairs. Nonetheless, a third, somewhat overlooked type of analysis exists – sentiment analysis. It might be perceived as undetermined and vague by some, but it’s just as important as the fundamental and technical analysis.

The overall feeling of the market has to be determined to understand the general idea of market participants pointed towards a particular asset. To put it simply, it’s the summarization of what traders think about a certain currency pair or will it go upwards or downwards. Sentiment analysis doesn’t give you information about when you should enter or exit the marketplace; rather it gives you time to determine which action fits your trading plan. So, how can the Forex sentiment be identified? Two tools can be used to identify the sentiment of the market:

  1. Contrarian Indicators – Trading Against the Trend

The name of this strategy speaks for itself – the orders are placed contrary to the ongoing trend, so this is called trading against the trend. The core idea of this strategy is to take advantage of the situation, which means buying an asset at a lower price while it’s bearish or sell at a higher price while it’s bullish. Traders hope the ongoing trend will reverse, and this shift results in closing deals with profits. Despite going against the golden rule of trading, “always trade with the trend”, this strategy might help you understand the Forex sentiment better. However, it is not suitable for all traders.

When it comes to indicators, while utilizing this strategy, the RSI – Relative Strength Index can be resourceful. On a chart, this indicator is depicted as a line that moves from 0 to 100:

  • 0 to 30 is oversold territory
  • 30 to 70 is neutral territory
  • 70 to 100 is overbought territory

When followed on a chart, this indicator can tell you if a certain asset is bought or sold by too many people and when it will reverse. Using this indicator as a part of your strategy can ease the process of pinpointing the moment you should open or close a trade. 

  1. Commitment of Trader report

Every Friday, the Commodity Futures Trading Commission or the CFTC publishes the Commitment of Traders (COT). This report shows all opened positions by small, commercial and non-commercial traders. The COT indicator has three lines for these three types of traders, which can help you see the correlation. For example, non-commercial traders’ actions can indicate trends, while commercial traders help in identifying pivot points. 

Lastly, this indicator won’t give you adequate signals on when to enter the market, but it can help determine your strategy and trading style. Exploring the Forex market sentiment can help you get a better in-depth analysis of the market and shape the path of your trading actions, while keeping an eye on other traders gives you the knowledge you should use wisely in your future trading endeavors.