In addition to technical and fundamental analysis, sentiment analysis has a great importance in the Forex market. The direction of price movement is not always can be explained by the fundamental factors influence or predicted by the technical indicators. Ordinary people, who are affected by mental impulses, fears, and sometimes the herd instinct, trade in the market. Therefore, a good trader must not only be well versed in the economies of countries and charts of technical analysis, but also he should to be a psychologist, able to anticipate people’s reactions to certain events.
How it works the example
Let’s suppose, you see that all technical indicators signal that the dollar/yen will rise. Fundamental analysis says the same thing. However, despite this, the dollar/yen continues to fall. What is the reason?
It’s the market sentiment that doesn’t subject to any laws and which cannot be predicted with formulas. If the majority of traders starts to hunt for some kind of currency, its price will move up regardless of the technical and fundamental factors.
The market sentiment
The market sentiment can change randomly every few minutes, or be set for a long time. The short-term sentiment can be the cause of corrective pullbacks, but in general everything comes back in the direction of the existing long-term trends. This is because sentiment is based on expectations, and when expectations are formed, they last for a long time. In fact, we never know when the market sentiment will change, before it has not happened.
The long-term sentiment
The long-term sentiment can act in the market for several months, and even years. Therefore, we can see long-term trends easily, exploring the technical analysis’ graphs. Even if all indicators demonstrate a falling of the currency, it’s not necessarily that it will happen, as the currency rate can be supported by investors ‘ expectations.
The trader doesn’t have to predict, how the GDP, average wages or other significant economic indicators will change, to understand the impact on the national currency. There are economists for this. It’s more important to track, how much changes of these indicators impact on market sentiment. If the majority of traders expect, that the currency will rise, the GDP decline or other economic factors couldn’t stop it.
If you see that on the chart there is a long-term rising trend that has not changed its direction, even when fundamental factors testify to the contrary, this means that the market is dominated by persistent expectations, and they should be taken into account.
Sentiment analysis of the market is the most difficult type of forecasting in the Forex. To learn it, you need to have a gut from birth or develop it through long workouts. However, it is quite real to master this type of analysis.