Education

Stay ahead of the curve with sentiment analysis

Forex education from LegacyFX

There
are a number of different strategies that traders use to govern their actions
or decision-making. One of the most effective is sentiment analysis, which
reflects simply understanding the current mood of the market.

The
market, like any person or individual is subject to different moods. Correctly
reading the market’s mood is crucial in making profit. Now, if you misread a
person’s mood you may end up accidentally feeling the effect of a person’s bad
mood. 

Take the first step to using sentiment
analysis
today

In
a similar way, if you are unaware of the market’s mood or sentiment, then you
may end up with a losing trade. The market constitutes an emotional melting
pot, prone to wild mood swings which can be overly optimistic or very
pessimistic. So how do you correctly read sentiment and keep in step with the
market’s present mood?

Sentiment
is short-term

Before
addressing this question, one of the key aspects to realize concerning
sentiment is its difference to fundamental analysis. Fundamental analysis
revolves around central bank monetary policy, which produce long shifts and
price movements influencing the market for days, weeks and even months.

In
contrast, sentiment can be affected by a range of different triggers, not just
monetary policy, and tends to be only short-term. As a general rule most
sentiment lasts from only between 1 and 3 market sessions. The market craves
and focuses on the freshest news. New information has the biggest effect on the
market as it digests and prices in the new information.

Look
at the previous two sessions for significant events

Thankfully,
analyzing sentiment is not a mysterious skill. At the start of every session
the latest sentiment will be obvious. If you read a previous session summary
you will usually become aware of the most significant events that took place.

So,
if you are coming to your desk at the start of the US session read through the
highlights for the previous two sessions. What significant events have just happened?
What was a surprise for the markets?

For
example, perhaps the UK’s CPI data was released in the London session and it
was a surprise beat to the upside. In this scenario GBP would be considered to
have a positive sentiment since traders would look to buy up the GBP. 

Or
maybe there was a political development that weighed on a particular currency.
For example, perhaps a Eurozone state was having an election and an anti-European
party was just found out be leading in the polls. This would have negative
sentiment for the EURO.

Pair
currencies with positive sentiment against currencies experiencing negative
sentiment

Continuing
with the example above, you would have discovered the market’s mood on two
currencies. Firstly, the GBP – the beat in CPI data would mean the GBP will
almost certainly be bought up in the coming session, pullbacks in the GBP would
most likely find buyers.

The
Euro would most likely be being sold as the market fears another country
pulling out of the Eurozone. Any rally would be sold. So, by analyzing the
sentiment or mood of the currencies you have a good pair to trade. EUR/GBP
short.

Use
sentiment to anchor stops

So,
let’s assume you have analyzed the sentiment of two opposing currency pairs. In
this case the EUR/GBP pair. How can you use that knowledge of sentiment to
place your stops in an intelligent place. Again, this involves quite a simple
approach.

Place
your stops above the price before the sentiment catalyst was released.
So, for example, let’s say that before the UK’s CPI data release the EUR/GBP
was trading at 0.8800. If you placed your stops above that level then you would
know, for that price to be breached, your sentimental analysis would have to
be wrong. In the example below the GBP/JPY pair rallied into a Friday’s
close on the 6th of July 2018 on some positive Brexit news. 

Different
ways of using sentiment

Sentiment
comes in different varieties and below is a brief list of some of the most
common types of sentiment:

Buying
the rumor sell the fact

When
positive data is released yet the currency falls – this happens when the market
has been expecting a certain outcome for some time. As soon as the data release
is confirmed the market simply ‘sells the fact’. Watch out for this sentiment
when a certain outcome is expected and happens just as forecast.

Fading
sentiment

This
is when you use the short-term sentiment in order to get into a trade at a
better price in line with the fundamentals of a currency. So, you are said to
‘fade’ the move.

If
something can’t rally on good news

Another market maxim is that if something can’t rally on good news it is a good
indicator that lower prices are ahead. This is linked to the heading above,
fading the sentiment, as traders take advantage of all positive sentiment to
fade in line with the broader direction of the market.

Overbought
and oversold conditions in the Commitment of Traders Report

The
COT report indicates the positions of traders. Whenever you see a fundamental
shift in monetary policy that catches traders unawares you can have quick
adjustments in price. When you have traders heavily positioned to one side of a
trade buying a certain position and
then monetary policy shifts many of those traders will be unwinding
their positions.

This
is a sentimental shift that you can take advantage of. A similar sentiment
trade would be with traders taking profit on overbought or oversold positions.

Risk-on
and risk off markets

In
a risk-on environment, traders rush to buy the traditional safe haven
currencies like JPY, CHF and the USD. Conversely, AUD and NZD will not be
bought. If you come to the market and find a risk on sentiment is in play, then
you will want to make sure you are not entering into any short JPY trades.

Sentiment
is simply the mood of the market. Understanding that mood will help you not
only stay on the right side of the market, but also help you to have the
correct expectations of what is influencing the mood of the marketright now.

– Article provided by LegacyFX. Click here to visit the broker’s site.

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