Would you ever consider driving a car over 100mph down the fast lane of a motorway when you have only just received your permit license?
If you are like most sane people, your answer should be a resounding no.
Unfortunately, when it comes to trading Binary Options, many people upon getting a grasp of the basics of Binary Options will go straight out and try put some large trades on various financial markets.
In the world of Binary Options, this is the equivalent of driving that car 100mph with very little knowledge of what you are going.
And yes, whilst it is true that you can learn from your mistakes, this would be a very costly mistake to make.
Fortunately, unlike driving a car, the knowledge required to successfully trade Binary Options doesn’t take anywhere near as long to learn.
Now that you hopefully have an understanding of what Binary Options are and how to trade them, the next step is to learn how to research how a particular financial asset (be it a currency or a commodity) has been behaving and if there is any news coming out which could affect the asset in the near future.
For it is only by knowing how something has behaved in the past and if there is an expected event which can change it in the future can we build up a probable hypothesis of what will happen; subsequently making more accurate predictions.
Fortunately, when it comes to analysing whether a financial asset is going to increase or decrease in price, there are two different schools of thoughts; and professional traders in both still make very good money from their respective investigative school of thought.
The first one type which we’d be looking at is:
When you think about trading online, one image which may come to your mind is of somebody sitting in front of a computer looking at charts, displaying all sorts of financial data.
Well when it comes to technical analysis, this isn’t too far from the truth.
Traders who prefer to use technical analysis (often referred to as technical traders) aren’t particularly bothered about the performance or intrinsic value of an underlying asset.
As such, technical traders will often use charts to plot the ups and downs of an asset price over a certain period of time; from the present moment going back to the previous day, week, etc.
Nearly always when looking such a chart, one would see the price of the asset in question rising up and going down on a regular basis.
However, when looking back over the whole time period shown on a chart, technical traders will look for trends and patterns.
What do I mean by trend or pattern?
Well suppose a chart represents the price movement of an asset over the previous day, by trend we mean the price overall being going down throughout the day (even though there are points in the day when it briefly goes the other way)!
Likewise with regards to patterns, we are looking at whether the asset price seems to be following a certain pattern of behaviour; maybe several times during the day the asset attains a certain value only to go down in price again, but never go any higher.
By observing such patterns, technical traders believe that they can build a guide on how the price of an asset is soon going to behave and (with regards to Binary Options) whether the asset price is going to increase or decrease in the near future.
In the eyes of a technical trader, what causes the price of any asset (be it currency, share, etc.) to go up or down is plain old Supply & Demand.
For as any expert trader knows, when trading on any financial asset, they are never the only trader buying or selling that asset (be it literally buying that asset or through some sort of derivative, such as a Binary Option).
Therefore as the sum total of all the other traders (referred to in investing/trading circles as the herd) make their trades, the price will adjust accordingly.
For instance, when more traders are buying an asset rather than selling it, the price of that asset will increase as there is greater demand and subsequently, less of it (supply) available.
Likewise when more people are selling an asset, the price of that asset will decrease as there is less demand for it and subsequently, more of it (supply) available.
Whilst I’d admit that this explanation of technical analysis is just the tip of the iceberg (there are a vast array of tools, indicators, etc. which technical traders use to help them identify the direction of a price) ultimately all these tools, indicators come back to the same basic principles.
Which is to look at the previous performance of a financial asset price and try spot any trends or patterns occurring.
Traders who use the fundamental analysis school of thought (referred to as fundamental traders) can be said to be pretty much the opposite of technical traders in everyway.
As for a fundamental trader, they aren’t really bothered about how the price of a financial asset has behaved in the recent past (like technical traders are).
Instead they are interested in the internal details of an asset; what is actually going on behind the asset share price to see if the asset is likely to shoot up or down in price anytime in the near future.
For example, if we were looking to trade the Great British Pound (GBP) against the United States Dollar (USD) as fundamental traders, we’d look to the near future to see if there were any planned news events, etc. occurring which could affect the value of the GBP against the USD.
So whilst technical traders are only really interested in the immediate price of an asset; is it worth more (or less) a fundamental trader is more interested in the behind scenes stuff, i.e. what is causing the price of an asset to go up or down and what impact this have on the future price of the asset.
SO WHICH TYPE IS REQUIRED FOR TRADING BINARY OPTIONS?
You may have noticed that I have written more in-depth about technical analysis than I did about fundamental analysis and there is a reason for this.
This being that when trading Binary Options, we are generally more interested in the price of an asset and which way it is heading.
As such we don’t really need to know too much about the reasons why an asset is worth the amount it is.
Or to put it another way, if you were to bet on the horses, you would only be interested in knowing which horse has won most races in the past and so has the best odds of winning this race.
You wouldn’t be to particularly bothered about the history of the horse, where he sleeps at night, what time in the day he undertakes his training regime, etc.
Having said that, please remember that whilst betting on the horses is gambling, with the usage of technical analysis skills, Binary options becomes more a form of trading than gambling.
Though as we’d uncover further on in the Psychology Of Trading, the difference between trading and gambling is largely due to the mindset one approaches these activities with.
Whilst most Binary Options traders would tend to look at the previous asset price value to try and predict the future of an asset price, (technical analysis) there will be a few times when a bit of fundamental analysis is required by a Binary Options trader.
One such time would be to look for any upcoming news about the asset in question which is planned to be announced during the time you are running your Binary Options trade.
For example, when trading any currency (Forex) via Binary Options, you would most definitely want to look at any upcoming currency announcements.
The reason for this is because unlike stocks, Forex is renowned for there to be regular news which almost without fail, have a sudden effect on the price of a currency.
To find out about the upcoming news events, feel free to look at a site like Forex Factory for the major currency changing news events coming up during the next 7 days.
Now that we have a basic understanding of fundamental and technical analysis, the differences between the two and what type of analysis you’d need when trading Binary Options, I think it is best that we now go on to discuss The Psychology Of Trading.