Sentiment Analysis Overview from a Fundamental Perspective

Fundamental Analysis and Sentiment Analysis are two of the most important subjects in Forex trading. In this Wiki, we will take a Sentiment Analysis Overview from a Fundamental Perspective and explore some ways to trade them.

This Wiki is part of our comprehensive Fundamental Analysis Wiki. Be sure to check that out HERE.

Sentiment Analysis Overview from a Fundamental Perspective

We have a comprehensive Wiki on Sentiment Analysis HERE. Here we will do a short explanation of Sentiment Analysis.

The other most common driver of fundamental information is something called sentiment. We have already mentioned sentiment a few times now but up to this point we have not provided a definition of what sentiment actually is. Let's try and break that down now.

Let’s first think of fundamentals as the big "Macro Picture" of the health of an economy. If the particular economy is performing well and interest rates are rising then we would expect the currency of that nation to move higher over the long run. People want to invest in growing and stable economies that are performing well so this means that they will need to buy the local currency of that economy in order to invest in it. This is the most basic picture we can come up with for what fundamentals are.

Well, we know that currency prices just don’t go up in a straight line. It would be nice but that’s not the reality, unfortunately. Even though the big picture fundamental outlook may be overall positive there will be many days where the price actually goes down against the fundamental trend. In these times this means that the sentiment of the day has turned negative and forced price to be temporarily out of line with the big picture fundamentals.

Sentiment, in its most basic form, is the "Mood" of the market right now in the "Current" trading session. It’s similar to fundamentals except it lasts for much shorter periods of time. Sentiment can be in line with the fundamentals but it can also move price in the opposite direction of the fundamentals. The interesting thing about sentiment is that it can last anywhere from a few seconds to many weeks depending on how strong that sentiment is.

The importance of this aspect of supply and demand cannot be underestimated. Sentiment is so important that you will spend most of your time trying to identify the current sentiment for your trading opportunities. This is especially true if you are a shorter-term trader such as a day trader. If you are a day trader you will need to be in tune with how the market is feeling all day while you are trading.

Day traders will always want to keep the big picture fundamentals in the back of their minds, but for their biggest concern is what the market is thinking right now so that they can jump in and hopefully make some pips in the current trading session.

The very best trades happen are when the current sentiment is in line with the big picture fundamentals. These are the easiest trades because you have the power of the longer-term investors using the fundamentals and the shorter-term hedge fund traders using the sentiment all pushing the price together in the same direction. This is when you can make a lot of pips very quickly with trades that never try to go against you. This is one of the most important concepts traders should learn.

The Best Trades

The very best trades look like the following:

• If fundamentals + and sentiment + then buy all day long at good buy points.
• If fundamentals – and sentiment – then sell/go short all day long at good sell points.

These are the type of trades that tend to last longer and move more in terms of pips or price. These are the trades that can make you a lot of money if you know how to identify the long-term fundamentals combined with the sentiment of the day properly.

Good Trades

Good trades look like the following:

If fundamentals are "Positive" and sentiment is "Negative" you have 2 options:

1. Allow the negative sentiment to bring the price back to where it makes fundamental sense to start buying again.
2. Trade the negative sentiment short against the positive fundamentals. This is where knowing how strong sentiment is will help you make some profitable trades against the big-picture fundamentals.

If fundamentals are "Negative" and sentiment is "Positive" you have 2 options:

1. Allow the positive sentiment to bring the price back to where it makes fundamental sense to start selling again.
2. Trade the positive sentiment long against the positive fundamentals. This is where knowing how strong sentiment is will help you make some profitable trades against the big-picture fundamentals.

At its most extreme, virtually nothing will stop a market until its participants have been fully satisfied. The markets are simply too large for one entity, authority, or even group of authorities to move prices in a direction that the markets don’t appear to want. Five billion dollars of transactions would represent a serious intervention by major a Central bank but would only represent less than 1% of the daily FX volume in the London trading session alone. But, when all of the big players agree that price should be moving in a particular direction this can lead to some fantastic trading opportunities with major upside potential for your trading account.

In later Wikis, we will expand on the concept of sentiment and give you the tools and strategies you need to trade with sentiment effectively. But for now, we just want you to understand that fundamentals that you determine by Fundamental Analysis are the big macro picture of what is going on in an economy and sentiment that you determine by Sentiment Analysis is the mood or the market right now in the current trading session. Sentiment is caused by fundamental economic data. Economic data releases and market-moving information that could come in many forms which we will discuss in other Wikis.

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