There’s something powerfully alluring about binary options. Maybe it’s the ease and simplicity with which traders can trade a wide variety of assets. Maybe it’s the enormous profits – 70-90% of your investment – that can be earned with the click of a mouse.
Maybe it’s the thrill of risking virtually your entire investment with each go.
It’s probably a combination of the three. Whatever the reason, binary options are intoxicating trading channels for many traders today. Binary options trading has taken off over the past five years, and there are no signs of it slowing down any time soon.
Heading into this dangerous field without a solid trading strategy, though, is just as foolish as making any other investment choice without a firm strategy. You need to have a method to the madness before you risk a single penny. Otherwise, you’ll put your capital at risk unnecessarily.
In this article, we’ll cover the basics of binary options trading strategy for the trader who wants to approach the business with intelligence and forethought.
Identify Your Goals and Preferences
The first step is to figure out why you’re trading binary options to begin with. Obviously, you want to make money, but how much do you want to make – and how quickly do you want to make it? This will determine how aggressive you are.
You also need to determine your preferences for assets. Some binary options traders do not believe it matters. I disagree. I think you’ll be more successful, ultimately, if you choose options for an asset that you understand (more on that later).
You can trade options for stocks, commodities, currency pairs, stock indices, and futures/futures indices. The most popular tend to be stocks and currency pairs; virtually any major options broker will have several choices for each asset class to choose from. You can find more exotic choices with some brokers, but the downside to those is that information for them is often harder to find.
Pick the asset class with which you are the most familiar. And ignore those who say you should trade a wide variety of assets; trading an unfamiliar asset is the same as flipping a coin and basing your trading strategy off of whether it lands heads or tails.
Knowledge is the Fundamental Key
The most important key to any successful trading strategy, to me, is knowledge – knowledge about the asset class; knowledge about the asset market; knowledge about the asset itself; and knowledge about how other traders view the asset.
The more you know, the more of an informed opinion you can form on what the asset will do in the near future. For example, if you’re trading binary options on Apple stock and you know the iPhone 100 will be released soon, you can probably bet that Apple’s stock will get a boost and probably rise – hopefully enough to make your investment pay off.
Similarly, if you understand what major forces move the market for your chosen asset, you can take advantage of current events as they happen to make a quick decision and invest in the appropriate options contract.
Having knowledge of your asset and how your asset performs in the market can give you the insight you need to make valuable strategic connections, such as…
The Domino Effect
I call this strategy the ‘domino effect’ because of what happens when you knock one domino into the next: it causes a predictable reaction.
Basically, you will learn that certain assets are related to other assets. When something happens to one, then, a reaction is created that results in the other asset rising or falling accordingly.
You can also call this the ‘chain gang’ effect. If one person chained to another person takes off running at full speed to the left, chances are his chained-up partner is going to go left too!
Similarly, you can look for assets that are connected to other assets to get a hint for what will happen. Take, for example, the relationship between gold and the Australian dollar (the Aussie). Australia is one of the world’s major producers of gold. So, when gold rises in value, you can bet that the Aussie will similarly rise in value. The same holds true in reverse; if gold falls, the Aussie might fall, too.
There is also a relationship between oil and the U.S. dollar. Oil is denominated in dollars, which means there is an inverse relationship between the two. If the dollar strengthens (i.e. rises in value), it becomes more expensive to buy oil, so the price of oil will probably drop (due to lessened demand). If the dollar decreases in price, it becomes more affordable to purchase oil, so that commodity’s price usually rises.
These relationships are not 100% fool-proof, naturally, but they do exist and can form the basis for your trading strategies. This effect is even greater when you trade with futures, since they are more sensitive and volatile and are more likely to be impacted by news that happens within the hour or within the trading day.
Learn as much as you can about your chosen asset. Find the relationships that cause the asset to rise or fall in price – then exploit them with your strategy.
Leveraging Technical Indicators
Technical indicators also offer a compelling piece of any trading strategy – and, according to who you talk to, form the basis of trading altogether.
I subscribe to a healthy mix of fundamental and technical analysis, but I do emphasize the big role technical indicators can play in any investment strategy. Two of the most popular indicators you can incorporate into your strategy are moving averages and stochastic crossovers.
A moving average is a running average of the value of a particular asset over a certain period of time. For example, a 20-day moving average takes the value of an asset (such as a stock’s price) and gives you the average of each price point over the past 20 days. A 50-day moving average does the same for a 50-day period. The goal is to help you identify trends by smoothing out day-to-day volatility.
One popular strategy is to overlay 50-day and 200-day MAs and look for when the two cross over each other. A bullish trading signal is given when the 50-day MA crosses above the longer MA; likewise, a bearish trading signal is given when the shorter MA crosses under the longer one. You can also look for when the price goes above both MAs as a bullish signal (especially when the 50-day MA is above the 200-day MA).
Stochastic Oscillators and Crossovers
Another tool is a stochastic oscillator. This is a metric that denotes momentum and uses support and resistance levels to attempt to predict when ‘turning points’ have been reached in the asset’s price.
You can find this tool if you look on a chart with the oscillator overlay selected. It appears at the bottom and features two horizontal lines labeled 80 and 20 (from a scale on the right-hand side). Plotted on the chart itself are the two moving averages you select.
You are essentially looking for when the two moving averages cross over each other above or below the 80 and 20 lines, respectively. For example, if the shorter moving average dives below the longer moving average while both are above the 80 line, that is a sell signal – because the asset is likely at the top of its range and ready to head downward. If the shorter moving average crosses above the longer moving average while both are below the 20 line, that is a buy signal.
Some traders rely exclusively on technical signals like the two above. I think you should include fundamental analysis, like the type explained above, in your strategy. Above all, learn all you can about your chosen asset. It’ll form the foundation for any successful strategy.