As promised, here I am with the 1st part of the guidelines on how to combine the two forms of analysis when preparing for trading.
At first, one should use fundamental analysis to help form the ‘big picture’ of what fundamental factors are driving the trend.
Half the battle is correctly forecasting the trend over the life of your option.
For example, if you assume that the ECB (European Central Bank) is going to announce an interest rate increase (which should send the EUR/USD higher), you might consider buying a call option with a weekly expiration, because you’d expect the EUR/USD to trend higher over the coming week.
The following stage it using technical analysis indicators such as Bollinger bands and moving averages to get a better sense of the strength of the trend.
More specifically, they use technical analysis indicators to make sure we have a reliable trend that is likely to continue over the life of the option.
Technical analysis is also used for timing the entry, which is the second half of a successful option trade.
However, traders must remember that even if all indicators suggest that there is a strong trend, price rarely moves in a straight line.
Even strong trends tend to go up and down within an overall rising or falling trading range or channel.
The meaning is that even if you correctly forecast the overall trend direction, you could still lose if you enter a trade just before the price makes one of its normal counter-moves against the trend.
For example, let’s say you buy a call option on the AUD/JPY because you see it’s trending higher, but you buy it when price is hitting the upper line of its ascending channel.
Price could bounce lower without getting back above your entry point before your call option expires, meaning you lost on that trade.
On the other hand, if you bought a call option when price was at the lower line of the ascending channel, your chances of a winning trade are better because price is more likely to move higher as it continues in the direction of the overall up trend.
In sum, traders should use fundamental analysis to understand what’s driving the current trend and whether these drivers are likely to continue working during the life of your option.
Traders should use technical analysis to confirm that the trend is reliable, and determine the best entry points and exit points, when the later are possible.
Well stay tune for the upcoming 2nd part of awesome trading guidelines!!! Peace!
Using the different types when trading
Posted on by Rick Silva