What is Sentiment Analysis and How It Can Help Your Trading

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Sentiment Analysis for Forex Trading

Forex sentiment analysis can be a useful tool to help traders understand and act on price behavior. While applying sound technical and fundamental analyses is key, having an additional feel for the market consensus can add depth to a trader’s view of forex and other markets. In this article, we outline what market sentiment is, how it relates to forex trading, and what the top sentiment indicators are.

What is Market Sentiment?

Market sentiment defines how investors feel about a particular market or financial instrument. As traders, sentiment becomes more positive as general market consensus becomes more positive. Likewise, if market participants begin to have a negative attitude, sentiment can become negative.

As such, traders use sentiment analysis to define a market as bullish or bearish , with a bear market characterized by assets going down, and a bull market by prices going up. Traders can gauge market sentiment by using a range of tools such as sentiment indicators (see below), and by simply watching the movement of the markets, using the resulting information to make their decisions.

What is Sentiment Analysis in forex trading?

Forex sentiment analysis is the process of identifying the positioning of traders, whether net long or net short, to influence your own trading decisions in the currency market. While sentiment analysis can be directly translated to forex, it is also used for stocks and other assets. Contrarian investors will look for crowds to either buy or sell a specific currency pair, while waiting to take a position in the opposite direction of sentiment.

How Forex Sentiment Analysis Works

An example of how sentiment analysis can be applied in forex trading is a large single movement in GBP/USD in 2020, with negative sentiment sending GBP slumping to a 31-year low following Britain’s vote to leave the European Union . After broadly positive sentiment in the year that followed, negative sentiment then took over much of 2020 again before prices started to trend higher in 2020.

Another example of net short sentiment can be seen in the EUR/GBP chart below, with 21.9% of traders net-long with a ratio of traders short to long at 3.58 to 1. The chart shows in blue the percentage of IG traders taking a net long position, and in red the percentage taking a net short position.

Chart to show net negative sentiment alongside price action

Rising sentiment may mean there are few traders left to keep pushing the trend up. In this case, traders may want to watch for a price reversal. On the other hand, a price moving lower, showing signals that it has topped may prompt a sentiment trader to enter short. The below chart shows an example of the EUR/USD pair experiencing net positive sentiment.

Chart to show net positive sentiment alongside price action

Using Sentiment Indicators

Sentiment indicators are numeric or graphic representations of how optimistic or pessimistic traders are about market conditions. This can refer to the percentage of trades that have taken a given position in a currency pair. For example, 70% of traders going long and 30% going short will simply mean 70% of traders are long on the currency pair.

The best sentiment indicators for forex traders include IG Client Sentiment (as seen in the charts above) and the Commitment of Traders (COT) Report.

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IG Client Sentiment

IG Client Sentiment can be a useful tool to incorporate into your trading strategy. It can give a helpful picture of the number of long and short trades occurring in a particular market, giving an impression of the turning points in sentiment. For more on this indicator and how it can assist your trading, be sure to click the link above.

Commitments of Traders Report

The Commitment of Traders (COC) Report, published weekly by the Commodity Futures Trading Commission (CFTC), is compiled from submissions from traders in the commodities markets, giving a picture of the commitment of classified trading groups. The CFTC’s report is released every Friday at 15:30 Eastern Time and can be a useful market signal.

Read more on market sentiment

For more information on market sentiment, check out our piece How to Read Risk ‘OFF’ or Risk ‘ON’ Sentiment , understand the predictions of 2020 being a ‘Risk Off’ year , and don’t forget to refer to the aforementioned IG Client Sentiment for a full, up-to-date picture of who’s long and who’s short.

DailyFX provides forex news and technical analysis on the trends that influence the global currency markets.

What is Sentiment Analysis and How It Can Help Your Trading

The market is a community of people which interact on a day to day basis. The purpose of their interaction is to buy or sell financial assets in order to make a profit out of price differentials. What any beginning and experienced trader need to understand is that price do not move up and down just randomly or driven by a mysterious force (or an occult conspiracy). The people who sell drive the market down and the people who buy it lift it up. They make the decision to buy or sell based on the view that they over a particular market or equity or any other financial instrument.

What is the market sentiment?

The market sentiment is the overall view that its participants have over a given period of time. The market can’t be moved by a single individual, even though it had a vast sum of money, so the combined force of a certain percentage of market participants is the one that drives prices.

Understanding how the other market participants view a certain financial instrument is crucial when trading as it can enable you to anticipate future move and avoid being trapped in the wrong side of the market.

By developing skills that can help you examine and determine the market sentiment you will have a highly valuable tool for forex analysis or equity analysis etc.

There no use of having tons of knowledge about the markets, trading, risk management etc., if you are not able to apply that information in order to understand how the market works and make good trading decisions.

Since the market sentiment can help you determine the overall view of its participants focusing on learning how to read it is essential.

To sum up, market sentiment refers to the general view of the majority of a particular market and it also represent one of the key elements a trader should learn how to master, no matter what type of analysis you need(forex analysis or commodity analysis etc.). Learn how to read it and you would be one step ahead in your trading adventure.

How to use sentiment analysis for stock market?

Can you predict how the stock market will react to certain news, posts, and conversations published online? Knowing how the financial market will behave can give you a competitive advantage and help avoid losses. An unexpected ally in predicting the changes in the stock prices are social media. Online news travels fast, making the stock market exchange even more susceptible to rapid changes.

If you look for an extreme example of how social media influences stock market, take a look at Kylie Jenners’ tweet about Snapchat.

Shortly after the message was posted online, the price of Snap, Snapchat parent company, fell by 8.5 percent.

Some players were able to benefit from the social media turmoil, The Big Short-style, and made $163 million.

All of that fuzz was based on one tweet with negative sentiment.

Imaging what could have been done, if you knew about the tweet moments after it was posted online.

You could’ve benefited from the knowledge in many ways – either selling the stocks before it all hits the fan or buying the stocks at a discount price.

That’s the power of sentiment analysis of online mentions.

This example is consistent with the Efficient Market Hypothesis. According to the hypothesis:

stock market prices are largely driven by new information and follow a random walk pattern.

Sentiment analysis is a perfect addition to all technical parameters you use to assess stock market performance.

Sentiment analysis has an effect on short-term price fluctuations.

Let’s crack the sentiment analysis for stock market.

Here’s what’s ahead of us today:

What is market sentiment?

The rise of social media platforms gave many people space to express their opinions. Everybody can discuss whatever topic they feel comfortable with, no matter whether they are experts in the field or not.

The development of smartphones, cellular networks, and widely available WiFi, made it easy for content to spread.

Today, information (also fake news and rumours) can travel with the speed of light, attracting attention of investors around the globe.

The amount of information, and the speed at which the information online spread, can have both a positive and negative effects on the price changes of stocks.

Including market sentiment in the analysis of stock portfolio will help you play the odds in your favour.

How does sentiment analysis work?

Let’s take a look at how sentiment analysis works.

After all, the algorithm is going to be one of the factors in your decision-making process. It’s important to understand how it works and how reliable the sentiment analysis is.

The old approach to sentiment analysis

Sentiment analysis used to be a binary solution — sentiment analysis tools would detect certain words and attached sentiment.

The solution had many drawbacks, and didn’t always assign right sentiment to the right mentions. It could have happened that an online post with positive sentiment is recognised as a negative one.

Another weakness of the binary solution are the language limitations. The algorithm deciphers the languages one by one, making it impossible to assess the results based on families of languages and the similarities between them.

Recent changes in sentiment analysis algorithms

As you can see, sentiment analysis, although very useful, had some serious drawbacks.

It has all changed recently.

Sentiment analysis algorithms became more sophisticated and more reliable.

I can show you how sentiment analysis works based on Brand24, a media monitoring tool.

The tool offers a state-of-the-art sentiment analysis algorithm.

The algorithm is based on a deep learning mechanism. The AI works similar to human brain — the sentiment algorithm will assign similar sentiment to words with similar meaning.

Moreover, the tool analyses sentiment based on the families of languages. That not only makes the algorithm more accurate, it also allows the tool to analyse sentiment of different dialects.

Sentiment analysis is available for more than 100 languages.

Sentiment analysis works both for mentions from news sites, forums, blogs, and social media mentions.

The social media platform of choice for financial journalists is Twitter. That makes it perfect for media monitoring and sentiment analysis for stock market.

Tweets regarding financial news are short, precise, and logical. These make them perfect for sentiment analysis.

Can market sentiment help predict changes in stock prices?

Does it sound too good to be true?

In the constant news cycle it’s hard to distinguish between well-researched information and an unverified piece of content.

You might have some questions about the use of market sentiment to predict changes in stock prices.

Sentiment analysis and stock market is a well-researched problem.

Our intuition tells us that price and sentiment are at least correlated. What we didn’t know is which factor had a primary effect on the stock market.

Does negative sentiment influence the stock prices? Or is it the other way around — the stock prices increased thus creating positive sentiment?

Applying sentiment analysis to predicting stock market returns has been studied widely by scholars from many universities, including Stanford University and University of London.

Every study confirmed a correlation between sentiment analysis and changes in stock market.

If there’s something to the theory, why not used it to your benefit?

Let’s see how to analyse sentiment quickly and efficiently.

How to monitor sentiment for stock market?

The quickest way to monitor sentiment analysis is to use a media monitoring tool.

I recommend Brand24, one of the most robust media monitoring tools, according to Buffer.

Brand24 collects all publicly available mentions containing your predefined keywords.

How does sentiment analysis for stock market work in practice?

Start with creating a project.

The project creation wizard consist of three steps. That seems like a lot, but it’s all to ensure you get the most accurate and relevant results.

In the first step, choose the keywords you want to track.

You can track any keyword you want.

Think about keywords used regularly in the same context of discussion as the companies you’re interested in. That could be the brand’s name, a hashtag used by some commentators on social media, or any other word that will help you collect the mentions you need.

In the last steps, you can specify the language you’d like to monitor and add some additional sources, for example, TripAdvisor. You can skip it, since you want to focus on sentiment analysis.

Let’s see how media monitoring and sentiment analysis work in practice.

I set up a project regarding universal basic income. Brand24 collects all publicly available mentions containing my keywords. The tool analyses the results as well.

That’s why I know that this mention published on Twitter is a negative one.

Brand24 will also collect news from media sites, for example this one, from Fortune.com:

Receiving your sentiment analysis results

When it comes to stock market, time is of the essence. You have to know about new comments right away.

Brand24 offers three types of notifications:

  1. Slack notifications. If you have a Slack account, I highly recommend connecting your project to one of your channels. You’ll receive a notification every time a new mention lands in your dashboard. You can set up filters and receive only negative mentions or all of them.
  2. In-app notification. Brand24 offers an app, both for iOS and Android. You can swiftly access your projects.
  3. Email notifications. You’ll receive an email every time there’s a sudden surge in the number of mentions regarding one of your projects.

When it comes to sentiment analysis for stock market, I believe that Slack notification are the most reliable option, followed by the in-app notifications.

Can sentiment analysis bring substantial value to your stock market plan?

It all comes down to money. Is investing in a sentiment analysis tool worth your money and time?

Markets are volatile. Every piece of information can have a positive or negative effect on the stock prices.

Because of the 24-hour news cycle, we’re constantly bombarded with information and data. At some point, it’s almost impossible to stay on top of things and distinguish important news from the less relevant one.

Media monitoring tool can help you stay on up-to-date. Based on the filters you set up, you’ll receive the news you’re most interested in.

Moreover, the world of social media is unpredictable. Even the most inconspicuous piece of information can snowball into a full-blown crisis.

Sentiment analysis and media monitoring will help you spot this kind of mentions in advance. You’ll be able to benefit from the positive news and shield yourself from the effects of negative ones.

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Content Manager at Brand24. An avid reader and amateur baker. Passionate about mountains, travelling, and jazz.

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