When trading Binary Options, one can use most of the established strategies that are usually applicable to normal assets such as CFDs, normal stocks and Forex. These include such strategies as trend trading, trading news events, equity pair trading etc.
However, given the unique payoff structure of Binary Options, there are many more Binary Option strategies that the trader can implement to make use of the payoff. These extend to such strategies as the Straddle, scalping and co-integration.
There is also a perception that Trading Binary Options profitably requires extensive experience. This is not entirely true as many of these strategies are easy to learn and implement. For example, understanding technical analysis is usually about spotting unique market trends with a number of different indicators.
In its simplest form, the drive behind most of these Binary Options strategies is to predict in which way the asset may go (or how it will behave) and enter either a CALL, a PUT or a combination of both. If one were to believe that the price of the asset would merely increase or decrease then the trader would either go long (CALL) or go short (PUT).
However, there are a number of situations in which the trader may not know definitively which direction the asset will go. In these cases, a combination of different options could yield a profitable outcome. Before you can begin trading, you need to set yourself up with a Binary Options broker. Assuming that you do not have a trading account yet, you can use one of our recommended brokers below.
Setting your Risk Tolerances
Before you actually start trading these Binary Option Strategies, you have to know exactly how much you are willing to risk on each trade. Not setting individual risk limits is one of the biggest mistakes that a trader can make before implementing any of these strategies.
Even with the best Binary Option strategies and the ideal conditions, the possibility exists for a row of successive losing trades. If this does occur, there is the chance that you could run through a large amount of your savings before the winning trades start coming in.
Money Management is Key
Money management is one of the most important strategies for a trader to learn and only disciplined traders can make long term gains. This involves not only knowing how much you are willing to risk but also not allowing emotional decisions about losses or gains impact your trading strategy.
As ex traders, we know all too well of examples of investors who chase losses unnecessarily or don’t know when to take a profit. Given the payoff structure of Binary Options, traders know with some certainty the potential losses and gains on each trade. However, making immediate decisions after a trade based purely on your emotions is a sure fire way to end up harming your trading record.
Many of the strategies mentioned below are traded with the help of either technical analysis, fundamental analysis or a combination of them. Given that most Binary Option brokers allow a whole range of assets to trade on, these strategies can be applied to most of them.
However, individual assets have unique idiosyncrasies which make them different from other underliers. For example, some currencies are more volatile than others and react to economic news in a more extreme manner. Similarly, some individual stocks react to company specific information which is hard to predict. Hence, it is advisable to pick only one or two assets to focus on as you implement these strategies.
The Straddle Strategy
A straddle is an established strategy that has been used by professional traders for years. This was first used as a volatility maximisation trade with traditional vanilla options. Professional traders and hedge funds would use a straddle when they knew that markets would be particularly volatile ahead of some news or general uncertainty.
This strategy also works well with Binary Options. Given their payoff, the trader knows with a certainty he will realise one of three potential outcomes. When implementing a straddle trade, the investor will enter both a CALL and a PUT option on the underlying asset.
When looking only at previous movements in the asset (technical analysis), a trader could enter a straddle expecting a sudden movement either way. In this case, the trader identifies a long term trend and expects it to continue. However, there could be a situation when there is a sudden jump in the price of the asset and he expects it to temporarily adjust.
In this case, the trader can enter a short term PUT option. The moment that the asset has fallen, the trader enters a longer term CALL option expecting the asset to return to its upward trend. Of course, the trader should be certain that the asset has not gone through a period where the trend is reversing.
A straddle can also be used if there is no certainty of direction of movement and only that the asset will react and be volatile. For example, from a fundamental analysis viewpoint, assume that there is an important news story that is about to hit the wires (Economic data or company reporting). In this case, the trader may not be certain of how the asset will move but that the news is sure to create volatility.
Binary Straddle Trading Example
In this case, entering both the CALL and PUT option allows the investor to effectively increase his / her chances that at the expiry of the option the trade will end up in the money. Taking a look at the example of the Euro vs. the Dollar (EURUSD) in the chart below.
As one can see, the important economic event here was the Fed increasing interest rates by 0.25%. This meant that the dollar strengthened considerably. Even though market consensus was mostly in agreement that it would be an increase in the base rate, an investor who had no view on the outcome could have made a profit. By simply entering a straddle by going long both a CALL and a PUT on the pair, a profit could have been attained.
In this case, the only scenario in which the straddle trade would not win would be if the pair did not adjust at all to the announcement.
Trend Trading Strategy
When it comes to technical trading, one of the strongest and most well-known is trend trading. The essential assumption behind trend trading is that the value of a stock, currency or commodity is influenced by previous movements in that asset. Hence, the trader is of the view that the asset will keep trending in the same direction.
Currencies and Stocks are usually quite volatile and identifying the trend requires the use of a few technical indicators. This is usually spotted by looking at Moving average indicators such as Simple Moving Average (SMA) and Exponential Moving Average (EMA). This is mostly included in any number of broker platforms and charting services.
In its simplest form, the trader enters a CALL option on the asset which is increasing in price and trending up and a PUT option on the asset that is trending down. If the investor’s view is held out, then the asset will be at a higher or lower level at expiry of the trade and he will realise his profit.
Taking a look at an example below, we can see the spot price of Gold. The individual bars (called candlesticks) represent the movement of Gold over a time period (this case a day). The indicators to watch though are the Moving Average lines. The MAs allow this investor to easily spot the downward trend of gold. This is shown by MAs which range from a shorter time period to a longer one. Although this trend may have been caused by a number of US macro-economic factors (increasing rates), the downward trend appears to be reinforcing trader’s views.
Binary Trend Trading Example
Another reason that trend trading can be so effective is that it has a feedback loop effect. Given that most professional investors use the strategy, when they see a negative trend forming, most tend to avoid or go short the asset. This means that the actions of the trader help reinforce the trend.
Trading Gaps in Asset Prices
Due to periods of market iliquidity, assets can have large jumps in their prices. This jump is termed a “gap”. This usually happens during pauses in trading such as over a weekend or overnight. For example, if the price of gold were to close at $1,190 on Friday evening but were to open on Monday morning at $1,1910, that jump of $10 is considered a gap and is an interesting trading opportunity.
The fundamental assumption behind Gap trading is the standard supply / demand principle. When an asset Gaps, investors will either want to buy or sell depending on whether the asset has gaped up or down. Gaps also occur at intraday periods. For example, a gap could appear right after a news event where investors may overreact.
Once the investor has spotted the Gap, there are numerous options that he / she can trade in order to take advantage of this. The investor will either enter a PUT or a CALL option depending on the direction of the gap. The timeframe for the trade is also very important. The timeframe is influenced by a number of factors including the type of the asset and the size of the gap. As a general rule of thumb, the bigger and faster the gap, the shorter the timeframe can be.
When the asset has had an outsized move, the chances of a quick correction are more likely. Conversely, if the gap is relatively minor in comparison to previous trading levels (for e.g. within one standard deviation), then a longer expiry time for the option should be considered.
Looking for an example of a gap trade, a prime example can be the recent flash crash of Sterling (GBPUSD). In early October of 2016, GBPUSD sunk unexpectedly below 1.2 and eventually reached 1.18. This was as a result of low market liquidity and automated sell orders from “algo” (Algorithmic) traders. One can see this below in the chart. To put the size of the gap into perspective, it breached 6 standard deviations.
Binary Gap Trading Example
If the trader wanted to profit from this fall, he could have entered a CALL option on GBPUSD the moment after the fall. There appeared to be enough time to implement this trade before the inevitable correction. This correction happened within a few minutes when the same algos started to realise the value in the pair. A binary option trader could have made a considerable gain on this trade.
This also appeared to have happened in 2010 when the Dow Jones suffered a similar crash. Gap trading can also be used in periods of flash jumps such as pronounced short squeezes.
Price Channel Strategy
As mentioned above, trend trading is one of the most practiced Binary Option Strategies. This strategy can however be extended to a number of other scenarios. An extension of this strategy is trading a price channel. A channel, in it’s simplest form, is a trend with an upper and lower boundary.
In a similar fashion as to how the investor identifies a normal trend, he / she will take a look at the Moving Averages of the asset. However, in the case of a channel, the investor will try and identify the upper and lower levels of the channel.
One can spot these levels by drawing a line through three recent high and low points. This will allow the trader to easily identify the channel zone in which the asset is likely to move. Although channel trading is an extension of trend trading, there can be cases in which the asset is neither trending up or down but is within a horizontal channel.
Channel trading is also a strategy that works well with Binary Options. In fact, most brokers these days offer specific “tunnel” options. There are a number of specific tunnel options that the investor can enter. These are based on whether the investor thinks that the option will either stay within or exit the tunnel.
The investor also has to decide on whether this will only occur at the end of the trade at expiry or whether it will happen at some stage prior to expiry. Absent any unforeseen events, a tunnel strategy that assumes the asset will remain within the channel is one of the best Binary Option strategies to implement. This however assumes that the boundaries and trend can be clearly identified.
Use Signal Services
Of course, there is an entire industry that works around providing traders reliable trading signals. These Binary Option Signal Providers use a number of technical indicators which can be used by the trader. Some signal providers have better track records than others which is why it is important to read signal service reviews. Some traders choose to use these signals exclusively to inform their decisions.
However, the best traders know that using a combination of your own Binary Option strategies and third party signals is the best way forward.