The Importance of Fundamental Analysis in Binary Options

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The Most Important Technical Indicators For Binary Options

Consider the following bets:

  • Pay $45 to bet that the price of gold will be above $1,250 at 1:30 p.m. today. Get $100 ($55 profit) if you win, lose $45 otherwise.
  • Receive $81 now to bet that NASDAQ US Tech 100 index will go below $2,224 at 2 p.m. today. Keep a profit of $81 if your prediction comes true. If it does not, lose $19.
  • Pay $77 to win $100 if the USD-JPY forex rate goes above 78.06 at 2 p.m. today; you lose $77 if it does not.
  • Gain $33 if you bet on the price of bitcoin will go below $379.5 at 3:00 p.m. today. If it doesn’t drop that much, lose $67.

Welcome to binary options. All or nothing, one or zero, these securities are available on Nadex and the Chicago Board Options Exchange (CBOE). Binary options allow traders to make time-bound conditional bets on predefined values of stock indices, forex, commodities, events, and even bitcoin values. Like a standard exchange-traded option, each binary option has an option premium ($45, $81, $77, and $33 in the examples above), a pre-determined strike price ($1,250, $2,244, 78.06, $379.5), and an expiry (1:30 p.m., 2 p.m., 3 p.m. today).

The differentiator is the settlement price that remains fixed at $0 or $100, depending on the option condition being fulfilled. It keeps the net profit (or loss) fixed. The option premium also remains between $0 and $100. (Related: Guide to trading binary options)

Calculating Probability

Since binary options are time-bound and condition-based, probability calculations play an important part in valuing these options. It all boils down to “What is the probability that the current gold price of $1,220 will move to $1,250 or above in the next four hours?“ The determining factors include:

  • Volatility (how much and is it sufficient to cross the threshold/strike price?),
  • The direction of the price move, and
  • Timing.

Technical indicators suitable for binary options trading should incorporate the above factors. One can take a binary option position based on spotting continued momentum or trend reversal patterns. Let’s look at some of the popular binary option technical indicators:

  • Wilder’s Directional Movement Indicators (DMI) Average Directional Index (ADX): Composed of three lines, namely ADX, DI+, and DI-, and their relative positions, this indicator aims to capture the strength of an already identified trend. Here is the table for interpreting the trends:

Position

Momentum

ADX Value > 25

ADX Value

Here is an illustration, using 3M Company (MMM) stock:

Image courtesy StockCharts.com

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Depending upon the identified momentum and trend strength, an appropriate buy/sell position could be taken.

  • Pivot Point(in conjunction with support and resistance levels): Pivot point analysis helps determine trends and directions for any given timeframe. Because of the flexibility in timing, pivot points can be used for binary options, particularly for trading highly liquid major currencies. A good example (with calculation and graphs) is included in the article Using Pivot Points in Forex Trading.
  • Commodity Channel Index (CCI): The CCI calculates the current price level of a security relative to the average price during any given timeframe. The average price level is usually the moving average. Time periods can be selected as desired, allowing the trader flexibility in choosing when a binary option expires. The CCI is useful in identifying new trends and extreme conditions of overbought/oversold securities. It is very popular among day traders for short-term trading and may be used with additional indicators such as oscillators. In the below formula “price” is the asset’s current price, “MA” is the moving average of the asset’s price, and “D” is the normal deviation from that average. High values above +100 indicate the start of a strong uptrend. Values below -100 indicate the start of a strong downtrend. The CCI is computed with the formula:

  • Stochastic Oscillator: In an interview, the creator of the Stochastic Oscillator, Dr. George Lane, said “it follows the speed or the momentum of price. As a rule, the momentum changes direction before price.” This important underlying detail indicates extreme cases of overbuying and overselling, allowing reversals for bullish and bearish phases to be identified. The crossover of %K and %D values indicate trade entry signals. Although a 14-day period is standard, binary option traders can use their own desired timeframes.

%K = 1 0 0 ( C − L14 H14 − L14 ) where: C = most recent closing price L14 = low of 14 previous trading sessions H14 = highest price traded during same 14-day period \begin &\text <\%K>= 100 \left ( \frac < \text– \text > < \text– \text > \right ) \\ &\textbf \\ &\text = \text \\ &\text = \text \\ &\text = \text \\ \end ​ %K = 1 0 0 ( H14 − L14 C − L14 ​ ) where: C = most recent closing price L14 = low of 14 previous trading sessions H14 = highest price traded during same 14-day period ​

Levels above 80 indicate overbought, while those below 20 indicate oversold.

  • Bollinger Bands: Bollinger bands capture an important aspect of volatility. They identify upper and lower levels as dynamically generated bands based on recent price moves of a security.

Commonly followed values are 12 for simple moving average and two for a standard deviation for top and bottom bands.

Contraction and expansion of the bands indicate reversal signals that help traders take appropriate positions in binary options. Overbought situations are indicated if the current market price (CMP) is above the top band. While overselling is indicated when the CMP is lower than the lower band.

A challenge in binary option trading is correctly predicting the sustainability of a trend over a given period. For example, a trader may take the right position for an index, predicting it would hit 1250 at the end of a five-hour period, but the level was achieved in the first two hours. Constant monitoring is needed for the rest of the three hours if the trader plans to hold the position until expiry, or a predetermined strategy should be executed (like squaring off the position) once the level is reached.

The Bottom Line:

The technical indicators discussed above should be used for timely actions with constant monitoring. One major disadvantage with technical indicators is that the results and calculations are based on past data and can generate false signals. Traders should practice caution with detailed backtesting and thorough analysis for high-risk, high-return assets like binary options.

Fundamental or Technical? Both!

Novice traders often wonder what should be their first steps, which strategy to choose and what to pay attention to when entering the global financial markets. One of the first things traders learn is that there are two distinct types of analysis — fundamental and technical. Each one has its advantages and disadvantages of its own. By combining them one might understand the markets better and estimate the future direction of the price movement with higher accuracy. In order to understand how to combine two types of analysis, we will first have to take a closer look at each of them and understand their distinct features.

Analysis types

Technical analysis is built around price chart analysis. Technical analysts use past price performance to draw certain conclusions and evaluate existing market conditions. By using support and resistance levels along with technical analysis indicators traders can determine optimal entry and exit points (when it is possible to open and close the deal). This analysis type can provide a plethora of useful information and help predict the direction of an upcoming trend. However, it can hardly tell what the price will be in the long run, as the price chart cannot provide extensive information on the future performance of an asset.

Fundamental analysis , on the other hand, is focused around the study of real-life events that can affect the asset price. A corporate news release can trigger a massive price swing. The direction of the latter will depend on the information provided in the said release. Good news (outstanding financial performance, new cost-cutting initiative, higher than expected growth prospects) positively affect intrinsic, in other words real, value of a company. Bad news (poor financial performance, negative press coverage) negatively affect intrinsic value and drag the market price down, as well. The same principles apply to currencies, commodities, ETFS and all exchange-traded assets.

How to combine?

Combining fundamental and technical analysis is not always easy, yet it can be useful in a number of ways. It is wise to keep track of recent trading volume and monitor the activity of other traders. A trader can use volume indicators to check the power of a prevailing trend — as a rule, trading volume goes up when a trend gains momentum. When the volume goes down, it can be a sign of an upcoming trend reversal. Market behavior is determined by the actions of individual traders. What other people think about the asset thus should be of utmost importance to you.

Traders who rely on fundamental analysis as their primary analysis tool may also incorporate technical indicators into their strategy. They can combine fundamental and technical principles. Traders can trace the connection between fundamental events and signals, received from technical indicators, and use it to spot certain patterns. As the market quite often tends to repeat itself, by being familiar with patterns you can get a competitive edge against other traders.

Conclusion

To sum it up, it is safe to say, that the two analysis methods can complement each other and do not have to compete for a place in your trading system. One of them relies heavily on the past performance of the market, the other is shifted towards future events. Both have their benefits as well as their disadvantages and, therefore, can be effectively merged into a unified trading system. Traders should also remember that no matter what analysis type they utilize, it is impossible to correctly estimate the future asset price 100% of the time.

NOTE: This article is not an investment advice. Any references to historical price movements or levels is informational and based on external analysis and we do not warranty that any such movements or levels are likely to reoccur in the future.
In accordance with European Securities and Markets Authority’s (ESMA) requirements, binary and digital options trading is only available to clients categorized as professional clients.

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Trading Guide: The Importance of Basic Math in Trading Binary Options

Trading in binary options isn’t only about the markets. Mathematics has a huge role to play and it governs the

Trading is about making money. Making money on the binary options market is about carefully analyzing statistics and ultimately about basic math. Binary option brokers, for the most part, profit from what their clients lose. They are targeting an equilibrium in the market when for every buyer there is a seller and vice versa (i.e. there should always be an even amount of puts and calls), but that is rarely the case.

Traders also need math to be on their side. And since the rules of trading binary options are already set, traders just need to make the calculations. Unlike forex or stock trading, the risk/reward ratio is non-negotiable in binary options trading. The only thing left to improve or control in a sense, is the win rate.

Let’s say we have a digital option with an 80% payout, this means that if a trader wants to break even he has to win 5 trades for every 4 losses. In other words, a trader needs to win more often than he loses just to break even.

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To be able to make any money with an 80% payout, the trader needs to be right at least 60% of the time. It’s tough for traders to be able to correctly analyze the market and predict its direction. They also need to pick the option type that will best suit their trading style and market conditions.

The market will either be trending, in a range or a mixture of the two. Traders need to pick their time to strike and need to trade with a clear idea of what they are looking for. Keep in mind that emotions and mathematics mix just as well as oil and water. Traders need mathematics on their side.

Improving the chances of every single trade being a winner is what actually puts basic math on the trader’s side.

Fundamental Analysis in Forex

The importance of fundamental Analysis in Forex

Fundamental analysis is an approach to analyzing the markets by taking into account factors such as the social, economic and political issues. These factors tend to influence the supply and demand of the security in the question.

Fundamental analysis is one of two ways to analyze the forex markets. The other approach is the more widely popular technical analysis.

Both fundamental and technical analyses are important when you want to study the markets. However, traders mostly ignore the fundamentals when trading currencies and focus only on the technical analysis.

The general argument is that day traders who only trade within a small time frame need not concern themselves with fundamentals. This is because fundamentals are what tend to impact longer-term trends.

However, regardless of whether you are day trading or swing trading, it is important to pay attention to the fundamental developments in the markets as well. You can actually expect to see losses on your trades if you trade blindly and based solely on technical analysis.

In this article, we cover what fundamental analysis is and why traders should pay attention to it.

What is fundamental analysis?

Fundamental analysis is the approach that looks at the intrinsic value of the investment. While this is the definition that is broadly used in the stock markets, it applies to the forex markets.

Fundamental analysis is the study of looking at the economic developments that can affect the value of a currency.

By understanding fundamental analysis, you can understand whether the currency is over or undervalued.

The markets are always forward-looking. Therefore, the price you see on the chart already discounts the available news at that time. However, as and when economic releases come out, the markets adjust to the updated information.

So understanding the fundamentals is an important aspect if you want to avoid any unpleasant market moves.

Fundamental analysis in the forex markets requires analyzing various economic indicators.

The Role of Interest Rates

The markets move based on the expectations of interest rates which are set by central banks. The banks set the rates by assessing economic indicators.

When the central bank tightens monetary policy, which essentially means raising interest rates, it indicates that the economy is moving at a steady pace. Inflation is rising and the GDP is expanding. The central bank raises interest rates which in turn reduces the money supply.

As a result of higher interest rates, the borrowing costs are higher and thus there is less money to go around. This creates demand for the currency in question. The central bank tightens monetary policy in order to avoid the economy from overheating.

On the other hand, a central bank can pursue a loose monetary policy. This is when the central bank signals that interest rates will fall.

A central bank pursues a loose monetary policy in order to stimulate growth in the economy. This can happen when inflation is weak, and the economy is not performing so well. By pursuing a loose monetary policy, a central bank basically makes borrowing cheap.

This, in turn, creates more supply of the money which then helps push inflation higher.

How does a central bank set interest rates?

As mentioned, interest rates form the core of currency trading. And they are based on the central bank’s board assessment of economic indicators. Many central banks around the world and especially those in the developed economies follow a dual mandate of maintaining price stability and job growth.

Thus, a central bank looks to two key indicators in assessing interest rates. These are:

Besides the above two, other key economic indicators include the gross domestic product (GDP), retail sales and some forward-looking indicators that can signal how the economy is likely to perform in the months ahead.

As traders, paying attention to these economic indicators can give you perspective into how the central bank will set interest rates.

Most central banks release their quarterly forecasts on GDP, unemployment and inflation. Keeping these as a benchmark, traders can assess how the economy has been faring.

Central banks in developed economies often set a 2% inflation target rate. Therefore, traders can assess the trends in inflation to determine the outcome of the central bank’s interest rate decisions.

For example, when inflation trends show that consumer prices will most likely fall in the coming months, you can expect the central bank to be dovish in its message. This in turn can have a downside affect on the currencies, leading to a lower value against its peers.

Conversely, when inflation trends show that consumer prices will rise, it can signal that the central bank will be hawkish in its message. Traders can look at the inflation trends and thus understand that the markets will be positioning themselves for the currency to appreciate.

Do you have to be an economist to understand the fundamentals in forex?

The answer is no! You do not need to hold a degree in economics to understand fundamentals in the forex markets. However, having a basic idea of economic indicators can be beneficial to you in understanding the impact it can have in the forex markets.

One of the simplest ways to get started is by following the economic calendar. The forex economic calendar gives you a schedule of the economic events that will occur over the course of the day, week or month.

The economic calendar also gives you more details, such as the amount of impact the economic release will have on the currencies, the time it will be released and the forecasts/previous readings.

Based on this you can then make a fair judgement on how the currency might move.

For example, if you’re looking at the monthly labor market report, you know it’s better when the unemployment rate falls. Thus, looking at the forecasts and the previous month’s unemployment rate, you can expect the currency to be bullish if the actual data is better. (This means that the unemployment rate actually fell and was better compared to the previous month).

While you can’t expect to become familiar with the forex fundamentals overnight, having a steady eye on the market news as it develops can be a good start.

Are there any benefits of fundamental analysis in the forex markets?

Fundamental analysis is one of the two main pillars of studying the currency markets, or for that matter any other type of financial markets. Fundamental analysis will allow you to understand the factors behind the price action.

Technical analysis, on the other hand, is the study of the history of price used to predict future price movements.

Thus, when you combine both technical analysis and fundamental analysis, you can build a bigger, clearer picture. Only by combining the two can you understand why price bounced off a support level. Or if a breakout from the resistance level was indeed valid and backed by the fundamentals justifying the move.

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