When individuals first embark on a binary options trading adventure, much of their time is generally spent researching the set of assets that their brokers makes available. Not long after starting, however, investors need to start thinking about what kind of trading strategy they should pursue. The goal, of course, is to generate a good return on your invested capital, but not all approaches to market analysis are equally suited to generating attractive returns. In this article we evaluate two of the main schools of techniques that people use when figuring out what approaches they should take in order to maximize returns.
The first thing to understand about trading approaches is that they typically fall into one of two schools of thought: technical analysis and fundamental analysis. For many years, both schools have provided some investors with great success (and some others with great failure). On the fundamentals side, Warren Buffett is a great example – arguably the greatest example – of a successful fundamentals-oriented investor. On the technical side, major hedge fund firms including Renaissance Technologies provide strong examples of the success made possible by that approach.
What is technical analysis?
In a nutshell, technical analysis refers to investment analysis techniques that rely on analyzing the past price performance of an asset to make conjectures about the likely future price performance of that asset. It is a very broad domain, and includes many sub-techniques, but the general assumption of this approach is that the past price movements provide information about the future price movements of an asset. So though the analysis of historical prices, proponents argue, it is possible to develop a strategy that more often than not correctly predicts the future price movements.
As alluded to above, there are many different forms of technical analysis. Some of the well-worn techniques include Bollinger Bands and other market volatility-based techniques that involve making trading decision based on the moving average (or derivatives of that moving average) of an asset price. A full investigation into the various types of this analysis is beyond the scope of this article, but other noteworthy techniques include momentum-based approaches (such as the relative strength index and stochastic oscillators) and trend-based approaches (moving average convergence/divergence and the vortex indicator).
What is fundamental analysis?
Unlike technical analysis, fundamental analysis involves the analysis of an assets fundamentals in order to make investment decisions. The key point here is that the current price of an asset is important, but that other metrics pertaining to the asset – including hard metrics such as revenue, profitability and various ratios, and soft metrics such as management team cohesiveness, and brand reputation – will have an impact on the future price of the asset.
Fundamentals-oriented investors typically seek to determine what the ‘fair value’ of an asset is, and then to determine if the ‘fair value’ implies that the asset is relatively undervalued or relatively overvalued. In instances where the investor believes that the asset is undervalued, he or she will typically take a long position in that asset. Conversely, in cases where an investor believes that the asset is overvalued, he or she will typically take a short position in that asset. Regardless of the spot value of the asset, this approach assumes that the spot price of the asset will converge with the ‘fair value’ of the asset. If and when the convergence occurs, the investor who correctly determined the ‘fair value’ can profit.
What approach is right for you?
When pursuing trading in the options market there are many possibilities available to you in terms of how you inform your investment decisions. If you opt for technical approaches, you will need to be comfortable with statistics, and you will need to have confidence that past prices provide a window in to future prices. In contrast, if you opt for fundamental approaches, you will need to have ‘big picture’ thinking style and will need to master various accounting concepts such as discounted cash flow models and fair value. The best way to determine what strategy is best suited to you is to spend some time experimenting with both.
My name is Derek, and I have my Bachelors Degree in Finance from Grand Valley State University. After graduation, I was not able to find a job that fully utilized my degree, but I still had a passion for Finance! So, I decided to focus my passion in the stock market. I studied Cash Flows, Balance Sheets, and Income Statements, put some money into the market and saw a good return on my investment. As satisfying as this was, I still felt that something was missing. I have a passion for Finance, but I also have a passion for people. If you have a willingness to learn, I will continue to teach.