There are many ways to level up your Forex skills, but defining the trends is a necessity if you want to place successful orders. So, how do you identify a trend? That’s where Forex sentiment analysis comes in handy.
Forex, without any doubt, demands attention to many details and a thorough analysis of the current market situation. Investors use fundamental and technical analysis to achieve this perfect balance of being informed and making their own trading decisions. However, there is a third type of analysis - a bit more vague yet just as important.
Forex sentiment analysis helps you understand the overall feeling of the market participants towards a particular asset. To put it simply, it’s a summary of what traders think about the currency pair - will the price go up or down. Forex sentiment analysis doesn’t give you the exact information on when to enter and exit the market but gives you room for action best tailored for your trading strategy. So, how do you identify the Forex sentiment?
In other financial markets like stock trading, you can access the traded volume and define the “crowd-pleaser” pretty quickly. However, when it comes to Forex, you can use two tools that will help you:
- Contrarian Indicators
- Commitment of Traders report
- Contrarian Indicators
The contrarian trading strategy is pretty simple to explain. The name speaks for itself - those who use this type of trading place their orders contrary to the trend. It’s all about taking advantage of the situation. Basically, you can buy assets at a lower price while the trend is bearish and sell at a higher price if the bulls push it up. Those traders expect the trend to reverse, allowing them to close their deal in profit.
Contrarian traders go against the first rule of trading: always follow the trend. This strategy might not be suitable for all traders, especially those who have just started their Forex journey. However, you can use contrarian indicators to make sure you better understand Forex sentiment.
One of the best indicators for those purposes is the Relative Strenght Index (RSI).
On a chart, you can see RSI as a line that moves between 0 to 100, where:
- 0 to 30 is an oversold territory
- 30 to 70 is a neutral territory
- 70 to 100 is an overbought territory
What this indicator can tell you is: “Too many people sell/buy this asset, the price is going to reverse soon!”. Using it as a part of your trading strategy can really help you pinpoint the approximate moment you need to open or close your deal.
Commitment of Traders report
The Commodity Futures Trading Commission (CFTC) provides the Commitment of Traders (COT) report every Friday. This report shows the positions opened by three types of traders:
- Commercial traders
- Non-commercial traders
- Small traders
Commercial traders are financial institutions that want to protect their funds from market uncertainties. Their most distinctive characteristic is that they tend to open bearish positions when the price reaches its peak and vice versa. Non-commercial traders are all about making a profit. They are trend followers and always have open bullish positions when the price is rising and bearish when the price goals down. Small traders are hedge funds and individual traders who often tend to ignore big trends and might even go anti-trend.
To help you see the correlation, you can use the COT indicator, which usually has three lines for those types of traders. Non-commercial traders are excellent indicators of trends, while commercial traders can help you identify pivot points.
This indicator won’t give you a signal to enter the market at the exact time, but it will help you tailor your trading strategy and define your trading style. Forex market sentiment is a great way to analyse the market and help you shape the course of your future actions. Knowing other traders’ positions can be a gamechanger for you, so use this information wisely and have very successful trading!
