As a trader of binary options, you have to make predictions about future price movements of an asset. In regular trading, there are different ways to do that, but most commonly known is fundamental analysis.
This method examines earnings, dividends, new products, research projects etc. of an asset. Unfortunately, fundamental analysis is not adaptable to binary options. The only way to become a successful binary options trader is to use technical analysis.
How technical analysis can benefit your trading
The more you shorten the time period, the more random and erratic an asset’s price moves. These movements are no longer influenced by fundamental reasons, but are the result of random, unpredictable events that affect the relationship of supply and demand.
Someone might want to buy a stock because he has some money left over, someone else might sell because he needs money. These events are not always logical and too random to be predictable.
Traders therefore came up with a way of dealing with the unique challenges of random price movements: Technical analysis.
Technical analysis is based on three fundamental assumptions about markets and price movements:
1. Market movements discount everything
The price already reflects all relevant information that is influencing the price of an asset. It is therefore not necessary to know any fundamental information about an asset. By analyzing the price a trader can find out what investors think about an asset, and where the price will move in the future.
2. Prices move in trends
Technical analysts believe that prices move in trends. Trends are zigzag movements in a certain direction, either up, down, or sideways. On different time scales, an asset can go through multiple trends at the same time, often even through trends in different directions.
3. History will repeat itself
Thirdly, investors will repeat the behavior of investors before them. That means, although the market movements are random and irrational, they can be predicted if a trader recognizes patterns and draws the right conclusion from them. Two results of this assumption are trend analysis and candlestick patterns.
In other words, technical analysts ignore the question of why prices will move up or down. Instead, they focus on the simple statement that similar price movements have happened before, and most of the time created the same outcome. Therefore, a trader can assume that this outcome will likely happen again this time, and invest in this prediction.
Making good investments, especially on such short time scales as with binary options, is virtually impossible without technical analysis. Any new trader therefore has to invest a lot of time to master the basics of technical analysis. Any successful trading strategy for binary option has to be based on technical analysis.
Why fundamental analysis does not work with binary options
While fundamental analysis can predict whether an assets price will rise or fall over the next few years, it cannot predict whether the price will rise or fall right now. Even when there is new news, fundamental analysis cannot make a prediction about how far increasing profits will make a stock’s price rise today, for example.
That means, as a binary options trader you have to throw all classic assumptions about trading stocks over board. You should never predict rising prices for a stock because the company has great products and a growing loyal consumer base. These things will not affect the stock’s price on time frames relevant to binary options.
As you can see from looking at the wavering line of a stock’s historical prices, even the best stock will have periods of falling prices, and even the worst stocks will have periods of rising prices.