In forex trading, sentiment analysis is a theory in analysis that focuses on the feeling or tone of the market. It is the type of analysis that advocates for not following popular trends.

Traders who use sentiment analysis believe that when many traders are inclining toward one currency direction, then it is a signal that there will be an inevitable shift in the near future.

Thus, instead of placing trades in the same direction as the masses, sentiment analysts usually place their trades in the opposite direction as they expect the shift to take place.

As an example, a trader using this strategy can place a sell order even when the value of a currency is appreciating.

This is because according to sentiment analysis, when the majority of the traders have opened buy positions, then the currency will be overbought and there would be a shift in its direction.

What is forex market sentiment?

The forex market has many players, including countries, big financial institutions, companies, and retail investors.

It is important to note that every market participant has his or her own opinion on why the market is behaving the way it does. Therefore, this opinion is manifested in whatever trade he or she decides to execute.

However, in spite of of how sure he or she is, the market may still behave contrary to his or her expectation. This is because the direction the market is likely to take is usually determined by the dominating emotion or idea of the majority of the market participants.

And, this dominating emotion or idea about the direction of the market is what is referred to as forex market sentiment.

How to do sentiment analysis

Those who use sentiment analysis in trading forex aim to find the general feeling of investors about the condition of the market.

To help in knowing what investors are talking about and how they are gauging the condition of the market, sentiment analysts often undertake surveys to ask investors their feelings about the market.

In addition, some indicators used by sentiment analysts to know the general feeling of the market include proprietary bank flow data, COT data from CFTC, and special researches like those by MarketVane.

Click here to read more on the COT report.

After knowing the current market outlook, sentiment analysts then place their trades contrary to this.

As an example, if less than twenty percent of traders interviewed are confident of the future profitability of the market, sentiment analysts will look for long opportunities as they anticipate a shift in market direction.

Summary

If you want to carry out sentiment analysis as the basis of making your trade decisions, then it is important that you combine it with the other types of analysis.

If you use it alone, you may cause unnecessary damage to your trading account.