Understanding Market Sentiment Analysis in Forex Trading

In contrast to what some people think, forex trading is more than just an exchange of currency. It deals with various factors that can significantly affect the market. One of which is the market sentiment, which is essential in successful trading.

In this article, we’ll discuss what market sentiment is, along with its types, tools, and benefits.

What is Market Sentiment?

Market sentiment is the collective feeling of the traders and investors towards an underlying asset or financial market. Understanding market sentiment allows traders to judge whether the market status is positive or negative, which will help in the future prices of the assets.

Types of Market Sentiment

Market sentiment can generally be categorised into three main types:

1. Bullish Sentiment

If the market sentiment is more on the optimistic side, this means that it’s a bullish sentiment. When this happens, there’s an increase in the buying activity, which leads to a higher price of the underlying asset. As a result, there’s a chance of having capital gains and a positive outcome.

Although there are good things that come with following the behaviour of the market, it’s not always a good idea to look out for it. This is also why the basis of your strategy should heavily rely on market sentiment.

2. Bearish Sentiment

On the other hand, the bearish sentiment is when the traders expect that the value of an underlying asset will decrease. So, when the market is leaning towards a pessimistic view, it may result in a drive to sell, and the price continues to decrease.

For instance, if you’re still learning how to trade forex, and you encounter a bearish sentiment, you should be able to sell as quickly as possible before it significantly affects your trade.

3. Neutral Sentiment

Although most of the time the market sentiment leans towards bearish or bullish, there are rare instances that it becomes neutral. When this happens, there’s no clear view of the trend, and it’s impossible to use market sentiment as the basis of your trading strategy.

Tools for Market Sentiment Analysis

Now that you’re aware of the different types of market sentiment, the next is to learn how you can determine whether the market is in bullish, bearish, or neutral sentiment.

1. News Indicators

Of course, the market won’t react the way they do if there don’t have any basis. Some of the factors affecting market sentiment include company news, geopolitical events, and economic news. Traders, professionals and beginners, should monitor these factors in case some announcements can affect the currency rates.

2. Sentiment Indicators

Sentiment indicators are the most recommended in terms of judging how the market is feeling at the moment. However, these indicators should be considered with others when crafting your trading strategies. Instead, use it with fundamental and technical analysis.

Some of the most used sentiment indicators include the following:

• COT (Commitment of Traders)- shows the status of the biggest traders in terms of how committed they are to the current market trends.
• Sentiment Ratio- the ratio of whether the market is leaning towards the bullish or bearish sentiment.
• VIX (Volatility Index)- monitors the options prices. It’s also known as the fear index.
• Moving Averages- identifies whether the forex market is about to get lower or higher than its current state.

3. Social Media 

With the use of social media platforms, you can also monitor real-time market sentiment. Usually, people express their opinions online, and if they think there are some changes in the currency rates, they can easily let other people know what they think.

In addition, you can easily get updates on the latest currency rates from various countries.

Benefits of Market Sentiment Analysis

When you incorporate market sentiments in your forex trading strategy, you can encounter various benefits. Some of these benefits include the following:

1. Knowing the potential trend shifts

If you know the market sentiments, you’ll also be aware of the potential shift in the market trends, even before they reach the charts.

2. Better risk management plans

Once you understand the market sentiment, it’s easier to identify the right risk management tools you can use when trading forex. For instance, if there’s current news that will affect the currency prices, you can adjust your trading plan accordingly.

3. Opportunities to go against the market

If you would like to try being a contrarian forex trader, understanding market sentiment can help you plan how to go against the market.

Final Thoughts

If you know how to trade forex, and you utilise market sentiment analysis combined with fundamental and technical analysis. In doing so, you can be well-informed about the currency values and will be able to make an informed decision.

We hope this article helps you understand more about market sentiment analysis in forex trading. If you want to share your experience in using market sentiment along with your trading strategy, don’t hesitate to leave a comment below!

ABOUT THE AUTHOR

Aliana Baraquio has over 5 years of experience as a writer and market analyst. She specializes in developing beginner-friendly trading techniques and tutorials. Additionally, she suggests FP Markets as the top broker for trading CFDs and Forex.