Why Binary Options Traders Must Utilize Fundamental Analysis
Since the emergence of binary options in the financial markets, this new market has largely been viewed as a speculative way of making money online. This is primarily because of the short-term nature of trading binary options as compared to traditional vanilla options. Binary options have expiry periods ranging from 60 seconds to about two weeks in most cases.
This is why most traders tend to focus more on technical analysis than fundamental analysis disregarding the fact that the price of the underlying asset could significantly be influenced by the fundamental outlook of the stock/asset in in question.
Ignoring the potential impact of fundamental analysis in binary options is a huge risk, and traders should actually embrace doing thorough analysis before placing their trades. Jason Collins, a senior analyst at OptionsClick, agrees that in order to succeed in binary options traders must utilize both technical and fundamental analysis.
In a recent conversation he said, "While binary options are typically a short-term method of making money online, traders cannot ignore the role played by the intrinsic aspects of the underlying assets, [which are long term in nature], because price movements of stocks and indices are generally determined by the activity of traditional investors (exchange based trading activity), and these investors base their decisions primarily on fundamental analysis."
In general terms, fundamental analysis is a method of evaluating an asset based on both the intrinsic and external factors that are likely to affect its price over a given period. Such factors include macroeconomic events, interest rates, financial and political policies, and environment, among others. In valuing stocks, items such as price to earnings ratio, profitability margins, earnings events and management changes as well as insider/institutional investor transactions can affect the price of the underlying asset.
Fundamental analysis in binary options
Now, in binary options, traders have the opportunity to trade currencies, stocks, indices and commodities via the same platform.
However, as many traders will find out, there are not many analysis tools to use when analyzing stocks and other assets. As such, wise traders try to use the trading platform in conjunction with third-party analysis tools and platforms such as the MetaTrader 4 platform to analyze the price of the underlying asset.
However, for some assets such as stocks, the MT4 platform may not be the ideal tool to use especially when attempting to analyze the fundamental aspects of the stock. In this case, traders have to turn to websites/platforms that provide financial data about stock trading and general investing. Some of these platforms also provide timely updates on market moving events such as insider transactions and guru picks which can be very useful in helping traders to make smart investment decisions.
For instance, if an insider takes a huge position in Twitter (TWTR), the shares of Twitter are likely to react accordingly. Knowing this in time could help traders make the right call. While long-term investors are more interested in following what Gurus (institutional investors and hedge fund managers) are adding to their holdings, traders would be interested in following their activity as timely as possible because for them, the important thing is to determine what direction the price of the stock could move in the coming trading sessions.
This is particularly important for binary options traders because with many binary options platforms, it is now possible to trade the shares of Apple (AAPL), Google (GOOG) and Barclays (ERO), among others. Therefore, if a trader wants to have the right picture before making a trade, then it would be right to also understand what positions major holders are taking in a particular stock. This provides a signal of what is likely to be the general direction of the stock (i.e., upward or downward) given the sentiments shown by major holders.
Most binary options are short term in nature, but some of the top binary options brokers have option types that take months to expire. Some even have end-of-year expiries, while others have six-month period expiries.
This means that fundamental analysis such as P/E ratios, P/S ratios and earnings growth can be applied in trading these types of binary options, and most importantly traders are able to apply more than just the technical view when making their decisions.
As such, traders can make more accurate decisions because in this case it is not just about interpreting technical data to predict the next move. Utilizing fundamental analysis in these types of binary options is likely to yield more than trying to use just technical analysis because a lot of events are bound to happen before the expiry period elapses.
With binary options, you only need to get the direction of the price correct to make a potential return of more than 80% among most brokerage platforms and thus getting your prediction correct is the difference between you making an 80% gain on your investment, or losing everything. Therefore, it is important to consider everything that could affect the price of the asset in question and that involves doing through fundamental analysis.
Conclusion
The bottom line is that fundamental analysis is the cornerstone of investing, and any type of investor including binary options investors and exchange-based traders rely on this type of analysis in making the right investment decisions.
Therefore, traders should not overlook this type of analysis even when trading short term instruments like binary options. This could be the difference between making money and losing all of it.
This article first appeared on GuruFocus.
