As traders or investors, advanced analytical knowledge accompanied by effective emotion control and fund management enables us to act successfully in foreign exchange markets (Forex). Sentimental analysis has recently entered the financial markets. Such an analysis involves examining the emotions of the market. This article aims to fully introduce such a phenomenon; so, we appreciate your attention until the end of the article.
How many types of analysis are available regarding financial markets?
In the Forex market, traders tend to utilize three main analyses: technical analysis, fundamental analysis, and sentimental analysis. If you are adequately familiar with all the analyses, you already know that the fundamental analysis provides us with a broad vision of the currency pair correlation, which is generally assessed based on economic indexes and world news. Technical analysis determines the trends and facilitates distinguishing the inflection points. Such an analysis can be seen in graphs and the analysis of trading charts.
Emotional indicators are, on the other hand, different. They send some signals to the traders in vital situations, informing them about whether there is a reversal. Sentimental analysis can be considered as well as the integration of both technical and fundamental analysis.
What is sentiment?
This is a factor indicating the attitude of traders and investors toward a macroeconomy. In other words, this analysis is a psychological one, which is used to analyze the emotions of markets and traders. Thus, it is a grave mistake to claim that only the two technical and fundamental analyses assume a critical role in financial markets.
There is a wide range of emotions involved in the financial markets; such as worry, anxiety, fear, and also positive ones. Accurate recognition of these emotions suggests what kinds of currencies and stocks are worth investing in; because in fact, it is the emotions of the traders that determine the trends of a market. If the overall attitude toward a particular currency is negative, no positive idea can be considered in that respect.
The application of the sentimental analysis is of crucial importance because the prices in a market are usually determined due to the position of traders in the market, and this emotion in a market explains the irrational market behavior as well as indicates how effective the psychological state of trader can be on the fluctuations of currency rates.
How can the sentimental analysis of Forex be used?
Forex traders can determine the price action using sentimental or emotion-related indicators. These indicators include COT reports, the tendencies of the market, and the position of brokers. The sentimental analysis acts as the devil`s advocate; it helps maximize your future positions.
Knowing how people react in the face of different situations enables us to distinguish whether the market operates in the real direction or is based on pessimism and optimism. By having the right point of view, we can surf the sentiments of the market like a surfer and take advantage of the opportunities aimlessly created by others.
How do the sentimental indexes operate?
These indexes signify the percentage or raw data indicating the number of traders assuming a specific position in a particular currency pair; allowing us to draw an inference accordingly. Suppose that 100 traders have traded a currency pair. If 60 individuals intended long-term investment and 40 opted for short-term, it can be concluded that 60 percent of the traders have had long-term investments in the currency pair.
When the percentage of traders or trades reaches an extremely high rate, sentimental indexes rise to prominence. Let us explain what happens with an example. Imagine the above-mentioned currency pair is still rising, and 90 trades out of 100 are referred to as long-term investments (meaning that only 10 of them are short-term); thus, there are fewer traders left to keep to the rising trend.
The sentimental analysis here indicates that the time for price changes has come. When prices reduce and the signals suggest that the price had reached its peak, short-term traders come into action relying on the assumption that the long-term traders have to sell their stock to avoid further loss by reducing the price.
It is noteworthy that sentimental signals are not accurate ones for either buying or selling. Before considering them, you should still wait for the announcement of the reverse trend because it is likely that currencies remain at high price levels and refuse to be reversed immediately.
The commitment of Traders (COT)
This index, which is also known as COT, is one of the most popular tools for provident traders to have a sentimental sense of the market. The result of these reports is also applicable to spot trades. The COT of a society is announced by the Commodity Futures Trading Commission (CFTC) and its data is based on the positions held the previous Tuesday. This does not mean that there is no live data, but they are regarded as practical and helpful.
Because the published materials by the CFTC are so complicated to interpret, drawing graphs and analyzing the demonstrated levels are much easier ways to reach the sentiments via COT reports.
How to read the COT reports
The Barchart.com website provides users with data charts as well as future prices. COT data is not presented as a fraction of the number of short-term or long-term traders but as the number of trades that are either short-term or long-term.
Using the Put/Call ratio
This ratio demonstrates the upward (below 1) or downward (above 1) trends within a specific period. Several ups and downs may indicate an imminent reversal resulting from excessive purchases or sales; however, as mentioned below, this is not always the case.
The summary of position by the broker
Many Forex traders publish the total percentage of traders or the traders that are currently short-term or long-term in only one particular currency pair; just in favor of clarification. The data is only related to the clients of the same brokerage; this is why a narrow vision of the market`s sentiments is presented. The published data might resemble that of another brokerage.
Bear in mind that small brokerages that have fewer clients, cannot precisely indicate the sentiments of the whole market. However, bigger brokerages with more clients comprise a larger fraction of the market; thus, the data extracted from that can indicate the overall sentiments of the market better.
Some brokerages provide their clients or users with free sentimental tools. Examine some brokerages and see if their published reports are the same or not. If there is a sharp similarity, it means that the occurrence of a reverse trend is imminent. However, if the sentimental data items vastly differ from other brokerages, this index should not be used unless all the items start to become balanced. Some online sources, for example, have reported their sentimental index; for instance, DailyFx has published a freely available sentimental report as well as an interpretation of the means and approaches to data trading.
Greed and fear index
This is another index used in the sentimental analysis of Forex and ranges from zero to one hundred. The closer the index to zero, the more intense the sense of experienced fear. In this case, traders attempt to sell their assets anyway. On the other hand, the closer the index to one hundred, the more intense the sense of greed; meaning that individuals have a strong tendency to purchase various assets.
There are some determining parameters in this respect, such as currency price fluctuations, the daily trading volume, and public polls and surveys conducted. Such comments shared through social media can change the above-mentioned index.
Using bottom-up statistics
In the Forex market, no one is aware of the trading volume. However, some websites can offer limited statistics on the trader’s positions in a particular brokerage. For instance, the myfxbook website has a strong association and tends to offer market sentiment statistics to its users according to the comments and the positions of its users. The graphs and charts on the website demonstrate the percentage of traders in proportion to their positions. This is the link to the website:
https://www.myfxbook.com/en/community/outlook
Market sentiment limitation
Exactly like any other analysis, the Forex sentimental analysis does not necessarily present a hundred-percent sensible trading signal all the time. Sentimental indexes are only reliable when they accord with the trading trends. However, in terms of precisely determining the time when reverse trends occur, such indexes are less reliable because the interpretation of the climate of the market is ultimately intuitive.
Thus, as a professional trader, it is also worth confirming your ideas through fundamental and technical analysis. The RSI indicators are quite practical for confirming the trends. Meanwhile, considering the fundamental analysis helps you predict how your currency pair is likely to operate in the distant future. Always bear in mind that you have to deal with a live market, which can undergo moments of shock or tension, or unpredictable and sensational. And nothing is unchangeable.
Conclusion
In this article, we comprehensively explained the sentimental analysis of Forex as well as its relevant indexes. In other words, sentimental analysis is simply a psychological analysis approaching and assessing the sentiments and emotions of the market so that traders are provided with insights into their future trades as well as a proper understanding.