What is Sentiment Analysis and How It Can Help Your Trading

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How to Use Sentiment Analysis in Trading

The rise of technology has changed the way we communicate, and transfer information. Nowadays, our communication channels often happen through correspondence on messages, emails, and posts on social networks. While it is a very convenient way to transfer information and feelings, one of the big problems with the new way we communicate through technological tools is the difficulty of understanding the tone and emotion through the written words.

As a result, the Sentiment Analysis field evolved, with the goal of understanding the motivations, and emotions that drove the writer. This is a technical process designed to extract textual information from emotional characteristics, so that, for example, one can automatically understand whether a particular email is positive, negative or aggressive. Today, there are companies that provide this process as a service, and using advanced artificial intelligence techniques, in which they can analyze, for example, public opinion from Facebook comments or identify user needs from app store reviews.

Some of the best Sentiment Analysis companies in 2020 include Gavagai, Laxalytics, Lionbridge, Scale AI, and Monkey Learn.

What is Sentiment Analysis in trading?

Sentiment Analysis, also known as Opinion Mining, is a trading method in which a computer program tries to understand the public sentiment towards certain security. Sentiment Analysis in trading usually occurs through Machine Learning algorithmic trading systems that automatically scan and analyze thousands of market news or tweets and detect successful trades.

How to Trade with Sentiment Analysis

Well, if you are not familiar with coding and algorithmic trading, you might want to find a company that offers Sentiment Analysis AI services for you. For example, HedgeChatter is an AI-Driven Sentiment Analysis tool that uses social networks analysis to predict stocks and cryptocurrencies price movements. Another way to trade cryptocurrencies using Twitter Sentiment is through eToro that provides The TIE Long Only Sentiment AI portfolio.

If you want to feel more confident and do it on your own, there’s a ‘Trading Using Twitter Sentiment Analysis‘ course on Quantra, which seems to be pretty valuable according to the reviews.

There are other ways to invest in AI-Driven algorithmic trading software. Those include Neotic, Brand24, and CryptoMood.

Sentiment analysis of financial news articles and tweets with python

If you are a python (or JavaScript) programmer and want to create an algorithmic trading strategy using Sentiment Analysis, there are several guides and code sources that can help you get started.

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Obviously, you will have to find a trading software where you can integrate the algorithm and execute orders in the market. If you prefer to trade through stocks exchanges, the best option is brokers such as InteractiveBrokers that allow users to build their own automated trading algorithm using programming languages like Java, Python, and C++.

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.

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.

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.

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