Sentiment analysis is used to determine how other traders feel about the entire currency market or a specific currency pair.
We previously stated that price action should, in theory, reflect all relevant market information. Unfortunately, it isn’t that straightforward for us forex traders.
The forex markets do not simply reflect all available information since traders will all act in the same manner. Of course, that is not the case. This is why sentiment analysis is useful. Each trader has an opinion about why the market behaves the way it does and whether to trade in the market’s direction or against it.
The market is similar to Facebook in that it is a sophisticated network comprised of individuals who wish to spam our news feeds. Aside from that, the market essentially depicts how all traders, including you, Warren Buffet, and Celine from the donut store, feel about the market.
Regardless of the information available, each trader’s views and opinions, communicated through whatever position they adopt, contribute to the general sentiment of the market.
The problem is that as retail traders, no matter how strongly you believe in a particular transaction, you cannot influence the currency markets.
Even if you sincerely feel the currency will rise, but everyone else believes otherwise, there is little you can do. As a trader, you must take all of this into account. You must conduct sentiment analysis.
It is up to you to determine whether the market is bullish or bearish.
Then you must decide how you will apply your market sentiment perception to your trading approach.
It is entirely up to you whether you choose to ignore market sentiment. But, believe us when we say, it’s your loss!
Sentiment analysis is frequently employed as a contrarian indicator. There are a few theories as to why this is the case.
One theory is that if EVERYONE (or nearly everyone) shares the SAME attitude, it’s time to go hipster and trade against the mainstream emotion.
Unfortunately, the majority of retail forex traders fail. According to studies, between 70 and 80% of retail traders lose money.
So, if you know that all of these unprofitable traders who are always incorrect are all currently long EUR/USD.
It may be a good idea to perform the inverse of what they do!
Sentiment analysis, or the ability to gauge market sentiment, can be a valuable tool in your toolbox.