Sentiment Analysis is the art of not following the bandwagon. It effectively focuses on identifying the patterns of movement investors take on a subjective basis.
The theory goes that when a crowd is leaning too far in one direction, it is a sign that a change is about to occur.
Traders who utilize sentiment analysis look to investors to see what they are talking about, and how they are reacting to the market. In order to see what investors are talking about, those who research investor sentiment conduct surveys asking them what they believe the current market outlook is.
They then act contrary to the results. For example, if less than 5% of the investors surveyed are confident in the future profitability of a market, sentimental analysts will often increase a bet in the market with the expectation that a buying opportunity might be near.
To find out how investors are feeling, sentiment analysts, look for indicators such as VIX, COT data, and other proprietary research like SentimentTrader.
If the actions of investors seem to indicate that a currency will rise, those who use sentiment analysis will often sell, preparing for a fall in the price instead.