In this article we will explore sentiment trading in the Forex market. We will take a look at what sentiment is, why it is important, How to implement sentiment into Forex trading.

When talking about analyzing financial markets, technical analysis is usually most favoured, followed by fundamental analysis. To quickly recap, we say that Fundamental analysis focuses on news, economic indicators and governmental policies. Technical analysis is broader but mainly focuses on the charts and a trader’s behavior. Since behavioral trends tend to repeat themselves technical traders hope to benefit from the patterns on the chart moving in a similar fashion to what they did before at similar pricing levels.

Now recapped, below we will focus on sentiment analysis.

What is Sentiment Analysis?

Sentiment, in its most basic form, is the “Mood” of the market right now. This is the mood of the market in the current trading session, in real time, as price action is unfolding in front of you. In a nutshell, this concerns the market sentiment. How traders feel about the current market state. Optimistic (bullish, expecting the market to go higher) or pessimistic (bearish, expecting the market to slump).

As markets are normally moved by the flow of volume within a particular direction, you will find traders that rely solely on this type of analysis. Usually, those are long term traders (or investors with larger account balances) and more experienced ones. It’s certainly not recommended for day trading (even though many retail traders try to do it).

Sentiment can last anywhere from a few seconds all the way to many weeks depending on how strong that particular sentiment is. Sentiment is what creates supply or demand for a currency. This is otherwise known as selling (supply) or buying (demand). The importance of this cannot be underestimated.

No matter what or how you are trading one of your first goals should be to identify the prevailing sentiment in the market you are active in.

How to use it in Trading?

When the percentage of trades or traders in one position reaches an extreme level sentiment indicators become very useful. Assume our aforementioned currency pair continues to rise and eventually 90 of the 100 traders are long (10 are short); there are very few traders left to keep pushing the trend up. Sentiment indicates it is time to begin watching for a price reversal.

The Commitment of Traders (COT) is released every Friday by the Commodity Futures Trading Commission. The data is based on positions held as of the preceding Tuesday which means the data is not real-time, but it’s still useful. Interpreting the actual publications released by the Commodity Futures Trading Commission can be confusing and somewhat of an art. Therefore charting the data and interpreting the levels shown is an easier way to gauge sentiment via the COT reports.

Forex sentiment indicators come in several forms and from many sources. Using multiple sentiment indicators in conjunction with fundamental and technical analysis provides a broad view of how traders are maneuvering in the market. Sentiment indicators can alert you when a reversal is likely near – due to an extreme sentiment reading – and can also confirm a current trend. Sentiment indicators are not buying and selling signals on their own; look for the price to confirm what sentiment is indicating before acting on sentiment indicator reading.