Sentimental analysis in forex refers to identifying how traders trading the forex market feel about a particular instrument. Other types of analysis in forex trading are technical anlysis and fundamental analysis.
Because how other traders feel influence market movement, it is therefore a good thing to know what others are thinking.
The direction taken by the market is dependent on the feeling/opinion of all the market participants. This is because it is how they feel that dictates their actions. This is then reflected in the price of the instrument.
Types Of Sentiment
Bullish Sentiment: The market is said to have an overall bullish sentiment when the majority of market participants feel the instrument will rise in value. If this sentiment is maintained, the price of the instrument will rise.
When this is happening, we can say we are in a bull market.
Bearish Sentiment: When the market sentiment is bearish, the majority of market participants feel that the instrument will go lower. As prices drop, it makes more traders short the instrument reinforcing the sentiment.
When this happens, we can say we are in a bear market.
Using Sentimental Analysis
Sentimental Analysis can be applied to trading in two ways. These are the direct method and the contrarian method.
The direct method: The direct method of using sentimental analysis involves assessing and knowing what the market sentiment is. Once you determine the market sentiment, you place a trade along with the sentiment. Thus you are siding with the majority.
The contrarian method: The contrarian method involves identifying the market sentiment and placing a trade against it. The principle is over-saturation. This means when all the traders are taking long positions, for example. The contrarian trader takes a short position because the instrument will be overbought and the buyers will no longer have money to drive the trade up. As these traders unload their trades, the price will begin to fall. The reverse happens for bearish sentiment.
A popular and simple indicator that can be used to gauge market sentiment is the relative strength index (RSI). The RSI has three levels on a scale of 0 -100. These levels are the oversold, neutral and overbought levels. Generally, the instrument is oversold when the RSI value is below 30. When the RSI value is at 50, it is neutral. And finally, then the RSI value is above 70, the instrument is overbought.
In conclusion, it pays to know what the other traders in the forex market are feeling concerning an instrument as it can help in decision making.
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