Remember back when you enrolled yourself into the School of Pipsology, we talked about “The Big Three” types of market analysis. In case you forgot, they are:
- Fundamental Analysis
- Technical Analysis
- Sentiment Analysis
Why are we bringing this up again? Well, the good news is that these building blocks of analysis can also be used when trading binary options!
Trading the News
One way to make use of fundamental analysis would be to go with a trade-the-news strategy.
If you’ve gone through our lesson on this trading strategy, you would know that this is best applied to those events that usually cause a ton of volatility. The spike in volatility tends to lead to fast moves which can send price rocketing higher or plunging lower.
For binary options, this can be particularly effective when you trade simple Up/Down options.
After all, you would simply need to get an idea how price may react to better/worse than expected data and how strong the reaction may be. You just have to be confident that price can reach the strike price of the option that you bought.
For example, you plan to trade the Australian retail sales report. Let’s say you have a bullish bias on the results.
Chances are that a better-than-expected result will spur the Aussie to new highs, so you would look to buy a “call” option on AUD/USD.
Now let’s say that, as you expected, we saw a better-than-expected result. Luckily, AUD/USD also rose, rising above the strike price. Paycheck time, baby!
Of course, there are a couple of factors to take into consideration when playing the news.
First is the potential for volatility. When playing a news report and buying a binary option, you have to be fairly confident that the event will spark enough volatility so that price can reach the strike price and stay above/below that level.
If you try trading a report that rarely causes a ripple, you’ll be throwing money down the drain.
Second, you have to factor in the time component of binary options.
Remember, for the simple Up/Down options, price has to be above or below the strike price at the expiration date.
When trading binary options and implementing a trade-the-news strategy, you may also want to consider going with one-touch options since price would only have to touch and not necessarily close at a particular level.
You can also try the Out of Range options if you expect the price to move with strong momentum away from its previous range.
With this option you don’t have to pick a direction, just decide whether or not the market will move big time in one direction or another.
Love using those fancy-schmancy indicators like moving averages, Bollinger bands, and Stochastic?
Don’t be afraid to slap these indicators on your trading charts when you plan to trade binary options!
Remember, these indicators help you gauge where price action may be headed next.
These are used across all sorts of trading markets and not just spot currencies.
Just make sure you have a good understanding of how each indicator works before incorporating it into your analysis.
Studying technical levels and inflection points may also prove helpful when you trade binary options.
Let’s take a look at this example on GBP/USD.
Price has just broken down from a double top.
With this behavioral pattern, price normally continues to trade lower at a distance equivalent to the height of the double top.
One way you could play this is by taking a One-Touch trade.
If the strike price that your broker offers is somewhere between 1.5450-1.5550, which is within the height of the double top, buying a “put” option might be a setup worth considering.
Sentiment analysis is the task of measuring the market’s current “feeling” with regards to broad risk flows.
Are traders confident in buying up risky assets or would they rather reduce risk by buying safe-haven assets or going into cash? This type of analysis will prove to be particularly useful when trying to hop on trends.
Will EUR/USD break for new highs? Or do you think the trend is overdone and there’s not enough momentum? You can use sentiment analysis to gauge how the market is feeling.
If it seems that risk appetite is still at a high with no potential changes to the market themes in sight, then the chances are we could see the trend continue.
If you’re fairly confident that market sentiment will favor a risk-on environment, you could consider purchasing a “call” option on a risk currency or asset (e.g., Australian or New Zealand Dollar, Equities, Commodities, etc.)
On the flip side, if you think a reversal in sentiment is in play and depending on how overdone you believe the move is, you could consider purchasing a “put” option on those same risk currencies or assets.
Just as in spot forex trading, it’s not necessarily a case of choosing which type of analysis you’re going to use because they’re not mutually exclusive.
In fact, you can combine all of these types of analysis to form the basis of any trade that you take.
Fundamentals can help give you a bias as to what direction you want to take, while technical analysis will help determine the chances of the market reaching, breaking and finding support/resistance at a certain price.
Meanwhile, sentiment analysis may let you know whether the market is in a risk-on or risk-off mood.
In the end, the key is for you to learn from all your mistakes and gain experience. Over time, this process will help you fine tune your analysis and help you develop good trading practices.