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sentiment analysis

Sentiment analysis is the study of market psychology to predict future price movements. It is related to the overall feeling that market participants have about the performance of a particular currency pair.

Understanding the market sentiment is an important technique to learn, and can positively affect your trading decision making.

Lets have a look at two of the most widely used sentiment indicators, below.

 

 

Risk Appetite

 

Risk appetite, is a measure of how risky market participants are feeling about a particular currency pair.

When market participants are feeling optimistic or ‘in the mood’ for taking risk, they will buy riskier currency pairs that could potentially generate them more reward.

The term ‘risk on‘ reflects this, which means that higher potential yielding currency pairs will gather more demand from traders.

A good indication of when a currency pair is ‘risk on’ is when the price changes significantly over a short period of time.

Contrary, when traders are feeling less optimistic and ‘not in the mood’ for taking risk they will typically buy less risky currency pairs that will potentially generate less reward but may be a safer investment. 

The term ‘risk off‘ reflects this, which means that lower potential yielding currency pairs will gather more demand from traders. 

A good indication of when a currency pair is ‘risk off’ is when the price doesn’t change significantly over a short period of time.

risk

If you can understand what currency pairs are gaining demand, you know that their volatility will increase. Therefore, there is potentially higher chances of trends that you can ride.

 

 

Sentiment Indicator

 

A Sentiment Indicator is a numerical tool that shows which ‘side’ of the market traders are trading. It shows the percentage of traders that are buying that currency pair versus the percentage of trader that are selling that currency pair.

This indicator is a powerful tool simply because many retail traders are generally incorrect when it comes to making trading decisions. On average around 80% of retail Forex traders lose due to lack of basic trading education – unlike you!

It is human instinct to follow the crowd and trading is no different. Trading is commonly described as a ‘herd mentality’. What we mean by this is that when the price of a currency pair is increasing, the majority of the crowd will therefore be buying and vice versa when a currency pair is decreasing.

But this may not always be the most sensible or profitable decision. 

 

For example, 

A sentiment indicator shows us that 76% of traders have opened a long position of EUR:USD, meaning 24% of traders have opened a short position of EUR:USD. As most of the traders are long in the market, if you are following the ‘herd mentality’ then you would open a long position with the hope that the EUR:USD increases in price.

By looking and analysing other indicators, you can see that the EUR:USD is reaching a resistance point. Many of the traders who have already opened a long position of the EUR:USD may have stop-loss orders or other similar exit plans in place close to where the current price is heading.

If this price was to be reached there would be massive downward pressure and potentially a substantial decrease in price. Therefore, using all of this knowledge, you decide to open a short position before such a price is reached in order to ride the downward trend!

 

Think that the Market Sentiment would be a cool indicator to have in your trading set-up? Why don’t you use ours?

Everything Trading Pro+: Sentiment Indicator

 

 

BONUS:

Forex trading is commonly referred to as a ‘zero-sum‘ market. This means that when someone loses money, someone else is making money.

As you have learned, on average 80% of retail Forex traders lose money – therefore, 20% of retail Forex traders make money. Perfecting the use of sentiment analysis to get on the right side of a trade can be a very valuable skill to learn. 

LESSON SUMMARY:

– Sentiment analysis is the study of market psychology to predict future price movements. It is related to the overall feeling that market participants have about the performance of a particular currency pair.

– Risk appetite, is a measure of how risky market participants are feeling about a particular currency pair.

– The term ‘risk on’ means that higher potential yielding currency pairs will gather more demand from traders.

– The term ‘risk off’ means that lower potential yielding currency pairs will gather more demand from traders.

– A Sentiment Indicator is a numerical tool that shows which ‘side’ of the market traders are trading. It shows the percentage of traders that are buying that currency pair versus the percentage of trader that are selling that currency pair.

Lesson tags: free forex course
Back to: Free Forex Course > Step 4 - Analysing the Forex Market
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