Principles of Trading Binary Options

Many investors that wish to participate in the dynamics of market movements may encounter issues that will inhibit their performance and make it difficult for them to succeed.

Trading equity and stocks has high barriers of entry warranting high capital requirements to yield any merits that are worth the time commitment. Picking stocks that will succeed in the short-term is difficult, and investing in ETF’s requires time and patience.

Trading contracts for difference (CFD) and FX allows you to trade with less capital using leverage, but risks are magnified (see my other article about managing position risk with CFD’s). Additionally, you need to know how to anticipate short-run and long-run movements that may largely affect your position. Again, a large time commitment is required, and many assets run 24/5.

Trading traditional options and futures may require less starting capital, but far more fundamental and technical knowledge. It also takes a long time for your positions to develop before you see any profits.

For the investor that wishes to participate in the market without holding positions, or worrying about macro-movements, binary options serves as a great solution.

Binary options allow you to open and close orders within incredibly short time periods. As an asset’s price changes, moving along the chart, it is the goal of the investor to anticipate its movement relative to its current price level.

 

There are only three timeframes you need to consider.

A – is the current price of your asset, and the strike price at which options are placed.

B – is the time at which you can no longer enter a position.

C – is the expiry time.

Your goal is to decide whether the price of the asset will be higher or lower than that it currently is by the time of expiration (C), and designating a strike price (A) and direction – all before time runs out (B).

If you believe that the price of the asset will be higher at Point C than it currently is, then you exercise a CALL option.

If you believe that the price of the asset will be lower at Point C than it currently is, then you exercise a PUT option.

 

In traditional options for equity this gives you the right, but not the obligation, to buy or sell the asset for a fixed price at the time of expiration. With binary options returns are fixed. It doesn’t matter if you enter a call option and at the time of expiry the price has risen by 35%  – you still receive the same rate of profit, which varies between brokers.

Conversely, the most you stand to lose is the size of the position that you are in. If you enter a Call option worth $10 and the price drops at expiry, you lose $10 – unlike in Forex where losses can exceed your position size.

Here is a quick 50 second video of 1 option deal being exercised that I filmed. At the bottom of this article you can find two videos of me trading using the methods I cover in this article. 

Strategy

With binary options the most important thing is predicting short-term market movements.

Unlike with other instruments, where fundamentals guide the direction of the market and volatility yield highest returns, success in binary options trading comes from predictability and simple trend analysis. Low volatility assets, following the trend, and indicators, help traders make the right decisions.

 

Low Volatility Assets: Choose one asset; currency pair, index, or stock, and see how it behaves. It’s enough to be a specialist in only one and knowing it inside-out. Ask yourself:

  • How does the asset move when it’s having a good day?
  • What are some key patterns that happen often?
  • Is the trend predictable to some extent?

 

Following the Trend: Once you have chosen an asset identify its current trend.

Below I have drawn a trend line spanning 24 hours, I also added the moving average to show me which direction the price is going. Each bar on the chart is 60 minutes, and you can see that some are green and some are red. This tells us that the trend is upwards, EURUSD is increasing in price, but every hour or so it decreases. We are probably going to be using CALL options more than PUT options, but we need to look closer.

The chart is now zoomed in further and each bar is 5 minutes, in the center of the bars you can see the moving average now goes up and down. Although the general trend is still upwards now we can see that the price fluctuates significantly. Also our trend line becomes less significant at this scale.

We zoom in one more time, each bar is now 1 minute. Our original trend line looks almost horizontal due to the magnitude of the scale, but now we are able to establish an even smaller trend that lasts only 21 minutes. Now we are able to identify without calculations that the price moves up just about every 30 seconds and then slightly corrects before moving up again. Trading binary options within this trend – we would be exercising calls most of the time.

Use Indicators: Technical analysis indicators can help a trader identify behaviors or an asset’s price. They can also be used to help them anticipate what will happen next. Perfecting your skills of technical analysis can take years, but you don’t need to be a chartist to trade binary options (although it helps), and knowing at least a few indicators can dramatically increase your success rate.

Wilder’s Directional Movement Indicators (DMI) Average Directional Index (ADX): This indicator is also used by day traders to identify short term buying and selling opportunities.

Here is how it looks on the same trend that is above:

There are three lines you must look at in this indicator:

  • DI+ Line (the blue line)
  • DI- Line (the pink line)
  • The ADX histogram line (at the bottom of the indicator)

When D+ > D- it is an uptrend. If ADX < 20; trend is weak. If ADX > 20; trend is strong.

When D- > D+ it is a downtrend. Same ADX conditions apply.

This trend indicator allows you to measure the momentum of the asset price and figure out if the trend is sustainable or not. It may seem complicated, and in the heat of the moment difficult to understand, but think of it this way:

  • Are the lines crossing? -> Something is happening. Which line is on top?
  • Are the lines parallel? -> Nothing is happening. 

Bollinger Bands: This indicator allows you to see how the asset price is performing relative to its average movement. 

The center line (disregarding the moving average I placed before) is the center of the bands, and the average price within a certain time period. The upper and lower bands represent prices that are within two standard deviations of the mean. Price movements outside the bollinger bands are very irregular. If an asset’s price is trading close to one of the bands it is very likely that it will soon decline to the lower boundary and “correct” itself.

Stochastics Oscillator: This indicator helps identify when an asset has been overbought, and oversold, and is scheduled to make a turning point.

The two lines represent the current market (K) (blue), and (D) (orange) is the 3-period moving average of K. When the two lines intersect above the 80% boundary this signals that the asset is overbought – and most often a price decrease. If the lines keep intersecting the price generally keeps rising until the lines move on different tangents. When the two lines intersect below 20% this signals that the asset is oversold signaling a potential upwards price movement.

Example: Is the stochastics indicator telling you the asset is overbought? Yes. Has the D+ gone over the D- and the ADX is growing? Thats a very strong signal that the price is going to be going up even more! 

 

Bringing it All Together

Most binary options brokers will support the use of all three indicators at the same time. Load up the indicators into your trading platform, budget your position size before starting, and look at the trend.

I have provided another video with my own commentary so that you can see what it should look like when you put it all together.

Binary option trading can also include wagering on specific price levels, which involves a bit more of an understanding support and resistance levels. I’ve made another video demonstrating how I trade multiple price level binary options.

I was a bit in a rush to open all of the indicators, please note that there are certain settings that you can optimize to get a better read on the trend, but for the purpose of this video I just used the defaults.

 

Good luck trading! 

If you have questions -> ivan@ivanstruk.com

 

Disclaimer: I am not at the time of publishing affiliated with any brokerage service providing binary options nor do I practice binary options trading. The trades shown in this article are of my own execution on a demo platform. Nobody has paid me to write this article.

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