Fundamental Analysis For Binary Trading
To conduct fundamental analysis for binary options trading, the following methods can be adopted:
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1
Use financial ratios like the price-to-earnings ratio (P/E ratio), the price-to-book ratio (P/B ratio), etc.
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2
Study important economic indicators like Non-farm payrolls (NFP), Unemployment rate, and Consumer Price Index (CPI).
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3
Employ strategies that use fundamental analysis like News trading, Economic calendar trading, etc.
Fundamental analysis is a powerful method used in binary options trading to evaluate the real worth of an asset by scrutinizing various economic, financial, and qualitative factors. This technique allows traders to make predictions about future price movements. While technical analysis is prominently used for this approach to trading, an increasing interest towards application of fundamental analysis tools is being witnessed among traders. So, for those who wish to explore the latter, the experts at TU will in this article explore what fundamental analysis calls for and why it holds significant importance in the world of binary options trading.
Start binary options trading right now with Pocket Option!Introduction
For readers' better understanding, experts have taken a building-blocks approach in this article, where they start with a discussion on what fundamental analysis actually means and why it makes such a difference for many traders.
What is fundamental analysis?
Fundamental analysis is a comprehensive approach to assessing the true value of an asset. By analyzing a wide range of factors, including economic indicators, financial statements of companies, and global news events, traders can determine the intrinsic worth of an asset. This intrinsic worth is vital in forecasting the asset's future price movements, forming the basis for trading decisions.
Why is fundamental analysis important for binary options trading?
Fundamental analysis is considered important for binary options trading primarily as it solves the following three core purposes of traders:
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Predicting future price movements
By examining the intrinsic value of assets, traders can forecast their future price movements. This insight empowers traders to make well-informed choices on when to enter or exit trades, enhancing their chances of success. -
Identifying undervalued assets
Fundamental analysis is primarily used for identifying assets trading below their intrinsic value. Traders can seize these opportunities to purchase assets at a discounted rate, positioning themselves for potential profits as these assets appreciate in value. -
Risk management
Understanding the potential risks associated with different assets is an essential task in any risk management framework. Traders can employ the insights provided by fundamental analysis to make informed decisions about the size of their positions and how to manage risk effectively.
How to conduct fundamental analysis for binary options trading?
Experts have tried to sum-up the entire process of fundamental analysis for binary options trading in brief as follows:
Identifying the key factors that affect the price of the asset you are trading
The fundamental analysis journey begins with identifying the key factors that influence the price of the asset you're trading. These factors can include a wide range of elements, including economic indicators, company financial statements, global news events, and both qualitative and quantitative aspects. For example, if you're trading binary options on a company's stock, you'd want to scrutinize not only its financial performance but also factors such as market sentiment and global economic trends.
Gathering information from a variety of sources
You must gather reliable information from a diverse range of sources. This could include scanning financial news websites, keeping an eye on economic calendars, and examining company financial statements, among others. The aim is to create a comprehensive understanding of the factors that sway the asset's price. For instance, if you're considering an oil binary option trade, you'd want to track not only oil-related news but also the overall economic and geopolitical factors affecting oil prices.
Analyzing the information and making informed trading decisions
Once you've accumulated the necessary data, the next critical step is to analyze it and translate your findings into trading signals. This could involve comparing economic indicators against market expectations, analyzing company financial statements to judge the financial health of a company, or evaluating the repercussions of global news events on your asset's price. For example, if you're assessing a currency pair, understanding how economic data like employment figures compare to forecasts can be pivotal in forecasting the currency's future value.
Important financial ratios for fundamental analysis
Fundamental analysis in binary options trading isn't just about observing market trends and patterns. It delves deeper into assessing the financial health of the underlying assets. To navigate this complex terrain, traders turn to a set of critical financial ratios. Here, we'll explore these key ratios used in fundamental analysis, highlighting their significance and how to apply them effectively. These ratios are primarily applied to stocks.
| Financial ratio | Formula |
|---|---|
Price-to-earnings ratio (P/E ratio) |
Market Price per Share / Earnings per Share |
Price-to-book ratio (P/B ratio) |
Market Price per Share / Book Value per Share |
Dividend yield |
(Annual Dividends per Share / Market Price per Share) * 100 |
Debt-to-equity ratio |
Total Debt / Total Equity |
Return on equity (ROE) |
Net Income / Shareholders' Equity |
Price-to-earnings ratio (P/E ratio)
The P/E ratio compares a company's current share price to its earnings per share (EPS). In essence, it reveals how much investors are willing to pay for each dollar of earnings generated by the company. Understanding the P/E ratio is crucial because it provides insights into whether a stock is overvalued or undervalued.
A high P/E ratio relative to industry average or peers might signify that investors have high expectations for the company's growth and, as a result, the stock is overvalued. Conversely, a low P/E ratio suggests that the market has lower expectations for future growth, and the stock may be undervalued. As a binary options trader, this ratio is vital for estimating the potential direction of an asset's price.
Example
Consider the case of company A, a tech giant. If company A's stock is trading at $150 per share, and its EPS is $5, the P/E ratio is calculated as:
P/E ratio = Stock Price (P) / Earnings per Share (EPS)
P/E ratio = $150 / $5
P/E ratio = 30
This P/E ratio of 30 means that investors are willing to pay $30 for every $1 of company A's earnings.
Now let’s say the industry numbers are as follows
| Particulars | Company A | Company B | Company C | Industry Average (30 companies) |
|---|---|---|---|---|
|
P/E Ratio |
30 |
19 |
54 |
37 |
The best way to interpret this data would be as follows:
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Company A is relatively undervalued in its industry as suggested by a lower P/E ratio than industry average.
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Company B is more undervalued than company B, though more analysis is required to judge why its P/E ratio is so low compared to the industry average.
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Company C is priced higher than the industry, suggesting that it is a growth company. However, a more careful look is required to confirm this claim.
Price-to-earnings ratio (P/E ratio)
The P/B ratio evaluates a company's current share price to its book value per share. Book value, in this context, signifies the net asset value of the company, accounting for the value of its assets minus its liabilities.
A low P/B ratio might suggest an undervalued stock, indicating that investors can purchase it at a price less than its book value. On the contrary, a high P/B ratio can indicate an overvalued stock, potentially implying that investors are paying more than the company's assets are worth.
Example
Consider the case of company A. If company A’s stock is trading at $40 per share, and its book value per share is $30, the P/B ratio can be calculated as:
P/B ratio = Stock Price (P) / Book Value per Share (B)
P/B ratio = $40 / $30
P/B ratio = 1.33
This P/B ratio of 1.33 implies that investors are paying 1.33 times the book value for each share of company A.
Dividend yield
The dividend yield measures the annual dividend payment of a company in relation to its share price. This ratio is particularly significant for income-oriented investors who seek to generate income from their investments. In the context of binary options, dividend yield can be used to identify stocks that are likely to move in a certain direction. For example, if you are looking for stocks that are likely to go up in price, you could focus on stocks with high dividend yields. This is because high dividend yield stocks are often considered to be more stable and less likely to experience large price swings.
Example
Consider company A, a telecommunications conglomerate known for its dividend payments. If company A’s stock is trading at $30 per share, and it pays an annual dividend of $1.50 per share, the dividend yield can be calculated as:
Dividend Yield = Annual Dividend per Share / Stock Price
Dividend Yield = $1.50 / $30
Dividend Yield = 5%
This 5% dividend yield means that for every $30 invested in company A, an investor can expect to receive $1.50 in annual dividend payments. Comparing the same to its peers and broader market, traders can get some hint of possible price movements of options based on company A.
Debt-to-equity ratio
The debt-to-equity ratio provides an evaluation of a company's financial leverage by comparing its total debt to its total shareholder’s equity. It throws light on the extent to which a company relies on debt to finance its operations. For binary options traders, this ratio is an important indicator for assessing the potential financial risks associated with a company.
A high debt-to-equity ratio may indicate that the company is highly leveraged and might be at risk of default, especially if economic conditions worsen. It signifies that a significant portion of the company's financing is through debt, which could pose challenges in meeting its financial obligations.
Example
Consider company A, an automaker. If company A has total debt of $45 billion and total shareholder equity of $15 billion, the debt-to-equity ratio can be calculated as:
Debt-to-Equity Ratio = Total Debt / Total Shareholder Equity
Debt-to-Equity Ratio = $45 billion / $15 billion
Debt-to-Equity Ratio = 3
This debt-to-equity ratio of 3 implies that for every dollar of equity, company A has $3 in debt.
It suggests that company A relies heavily on debt financing for its operations, which may raise concerns among binary options traders regarding the company's financial stability. Traders focusing on long-term positions are likely to “down” the options of such companies, given that their observation is supported by other confirmations.
Return on equity (ROE)
The return on equity (ROE) is a profitability ratio that assesses a company's effectiveness in using its equity to generate profits. A high ROE can be considered a good sign, signaling that the company is able to generate higher profits using the shareholders’ investment. Again, “high” here means in relation to peers and industry average, not in absolute terms.
Example
If company A generates a net income of $40 billion and has shareholders' equity of $100 billion, the ROE can be calculated as:
ROE = Net Income / Shareholders' Equity
ROE = $40 billion / $100 billion
ROE = 40%
This indicates that for every dollar of equity, the company is generating 40 cents in profit.
Economic indicators for binary options trading
To take a comprehensive view, traders must also consider economic indicators, as they offer great insights into a country's economic performance. The effect of these indicators can be observed on almost all asset types, including stocks, Forex, and crypto.
Non-farm payrolls (NFP)
The Non-farm Payrolls (NFP) report is a monthly snapshot of the number of jobs added or lost in the US economy, excluding farm employment. It helps in gauging the economic health of the United States. Binary options traders closely monitor this indicator as it can significantly impact the value of the US dollar and other currencies. A higher-than-expected NFP report may indicate a robust US economy. Consequently, this can lead to a strengthening of the US dollar.
Example
Suppose the NFP report for a particular month shows that the US economy added 250,000 jobs, surpassing expectations of 180,000 jobs. This robust employment growth suggests a thriving economy, potentially strengthening the US dollar. Binary options traders might consider bullish positions on the USD or currency pairs involving the USD.
Unemployment rate
The unemployment rate reflects the percentage of the labor force that is currently unemployed and actively seeking employment. A lower unemployment rate often indicates a strong and robust economy, which can lead to a stronger currency. Further, when the unemployment rate decreases, the currency of that country may strengthen.
Example
If a country's unemployment rate drops from 6% to 4%, it suggests improved employment prospects and economic stability. As a result, binary options traders might anticipate appreciation in the country's currency value.
Consumer Price Index (CPI)
The Consumer Price Index (CPI) measures the average price of a basket of goods and services consumed by households. It serves as a crucial indicator for assessing inflationary pressures in an economy. A higher-than-expected CPI can indicate rising inflation, which, in turn, may lead to a weaker currency. This is because inflationary pressures can erode the purchasing power of a currency, making it less attractive to investors.
Example
Imagine that a country's CPI records a year-over-year increase of 3%, surpassing market expectations of 1.9%. This surge in consumer prices might raise concerns about inflation. Binary options traders could anticipate a depreciation of the country's currency due to the potential loss of its value.
Retail sales
Retail sales represent the total sales of goods and services by retailers within a specific timeframe, providing insights into consumer spending patterns. A higher-than-expected retail sales report may indicate robust consumer spending, which, in turn, can lead to a stronger currency.
Example
Suppose a country's retail sales data show a 5% increase compared to the previous month, surpassing market expectations of break-even. This surge in consumer spending suggests a vibrant economy. Binary options traders may anticipate a stronger currency due to the robust retail sales figures.
GDP growth
Gross Domestic Product (GDP) growth is a measure of the total value of goods and services produced by a country's economy within a specific period. It offers comprehensive insights into the overall health of an economy. When GDP growth exceeds expectations, it can lead to a stronger national currency.
Example
Suppose a country's GDP growth rate for the last quarter was 4%, surpassing market expectations of 3%. This rapid economic expansion suggests a thriving economy. Binary options traders might anticipate an appreciation of the country's currency due to the strong GDP growth.
Binary options trades and the factors that affect their performance
The major types of binary options trades include:
Call/put options
Call/put options represent the most fundamental binary options trade. Traders need to forecast whether an asset's price will increase or decrease within the designated time frame.
High/low options
High/low options share similarities with call/put options but offer a higher payout rate. Traders predict whether the asset's price will surpass or fall below a specified price level within a defined time frame.
Touch/no touch options
Touch/no touch options hinge on predicting whether the asset's price will either touch or not touch a specific price level within the allotted time frame.
In/out options
In/out options hinge on predicting whether the asset's price will remain within or extend beyond a particular price range within a given time frame.
Factors affecting binary options
| Factor | Description |
|---|---|
|
Asset price |
Most important factor; Profitability directly depends on accuracy of predicting the asset price. |
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Expiration time |
Time at which the binary options contract will expire; If the trader predicts the direction of the price movement correctly within the expiration time, the trade will be profitable. |
|
Strike price |
Price at which the binary options contract will expire; If the price of the underlying asset is above the strike price at the expiration time, the call option will be profitable. If the price of the underlying asset is below the strike price at the expiration time, the put option will be profitable. |
|
Time to expiry |
Amount of time that the binary options contract has left before it expires; A longer time to expiry gives the trader more time to predict the direction of the price movement correctly, though at the cost of higher premiums (lower payouts). |
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Asset volatility |
Measure of how much the price of the asset can move in a short period of time; A more volatile asset is more likely to experience large price swings, which can make it more difficult to predict the future direction of the price. Higher volatility translates to higher risk. |
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Risk tolerance |
Amount of risk that the trader is willing to accept; Higher risk tolerance may increase the reward potential, however, this exchange is often not recommended. |
Binary options trading strategies that incorporate fundamental analysis
Traders looking to incorporate fundamental analysis in their binary options trading strategies can look to the following options as their starting point:
News trading
News trading strategy for binary options aims to capitalize on news events and economic indicators. Traders closely monitor economic calendars to track upcoming news events and indicators, with a goal of gauging the expected impact of these occurrences to inform their trading decisions. For instance, if the eagerly awaited non-farm payrolls (NFP) report is anticipated to deliver positive results, traders may choose to buy call options on the US dollar, given that a favorable NFP report typically strengthens the US dollar.
Economic calendar trading
Economic calendar trading relies on essential economic indicators like GDP growth, inflation rates, and interest rates, where traders systematically follow economic calendars to stay informed about the release dates of these indicators, incorporating their potential influence into trading strategies. For example, if the Consumer Price Index (CPI) is expected to exceed projections, traders may opt to put options on the currency relevant to that country. A higher-than-expected CPI could indicate rising inflation, causing that currency to weaken against others.
Earnings trading
Earnings trading concentrates on company earnings reports and financial statements. Traders analyze these reports, gauging their anticipated impact on the market. For instance, if a company's earnings surpass expectations, traders may decide to purchase call options on that company's stock. Exceptional earnings performance often stimulates investor confidence, subsequently driving up the stock's price and making call options a strategic choice.
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Conclusion
By using the information provided by key economic indicators, financial ratios, and company-specific data, traders can judge an asset's intrinsic value and foresee its future price movements. Further, using fundamental analysis in conjunction with technical analysis enhances one's trading strategy, allowing for a more comprehensive understanding of the market's dynamics. Traders should also look to focus on the most relevant factors, utilizing a variety of sources, and recognizing the limitations of fundamental analysis.
FAQs
What is fundamental analysis in binary trading?
Fundamental analysis in binary trading involves evaluating the intrinsic value of assets by analyzing economic, financial, and qualitative factors to predict their price movements.
What is the best analysis for binary options?
The best analysis for binary options combines both fundamental and technical analysis to gain a comprehensive understanding of the market and make well-informed trading decisions.
How do you analyze binary trading?
Analyzing binary trading involves studying market trends, economic indicators, and asset-specific factors to predict price movements and make successful trades.
What are the fundamentals of binary options?
The fundamentals of binary options encompass understanding various trade types, risk management, asset selection, and utilizing both fundamental and technical analysis to make profitable trading decisions.
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Team that worked on the article
Chinmay Soni is a financial analyst with more than 5 years of experience in working with stocks, Forex, derivatives, and other assets. As a founder of a boutique research firm and an active researcher, he covers various industries and fields, providing insights backed by statistical data. He is also an educator in the field of finance and technology.
As an author for Traders Union, he contributes his deep analytical insights on various topics, taking into account various aspects.
Dr. BJ Johnson is a PhD in English Language and an editor with over 15 years of experience. He earned his degree in English Language in the U.S and the UK. In 2020, Dr. Johnson joined the Traders Union team. Since then, he has created over 100 exclusive articles and edited over 300 articles of other authors.
The topics he covers include trading signals, cryptocurrencies, Forex brokers, stock brokers, expert advisors, binary options. He has also worked on the ratings of brokers and many other materials.
Dr. BJ Johnson’s motto: It always seems impossible until it’s done. You can do it.
Mirjan Hipolito is a journalist and news editor at Traders Union. She is an expert crypto writer with five years of experience in the financial markets. Her specialties are daily market news, price predictions, and Initial Coin Offerings (ICO). Mirjan is a cryptocurrency and stock trader. This deep understanding of the finance sector allows her to create informative and engaging content that helps readers easily navigate the complexities of the crypto world.