Basic Binary Options Strategy

InvestingOnline.com 22/03/2018, 05:30

Every trader, at every level of experience, in every market seeks a trading strategy in which achieves just one single outcome: profit. But even the most advanced traders, with advanced strategies, begins trading with just one basic strategy.

For binary options traders who are not concerned with how much an asset moves in price, only direction, a basic strategy which succeeds in achieving consistent profits with a high probability setup is easily identified.

Trading Basics

For a binary options trader, even the most simple of strategies requires knowledge of share market basics. These include;

• Key markets: stocks, foreign exchange (FOREX), futures, commodity, indicies, options etc.
• Price and volume charting including chart types, basic chart patterns, increasing and deceasing volume etc.
• Market trading hours.
• Indicator types including volume, trend, momentum, volatility, moving average, linear etc.
• Order types: Long and short, call and put positions.
• Risk Management.

A solid knowledge of share market basics will allow a smoother transition to more advanced trading systems and strategies.

Types of Trading

Share market fundamentals arm a trader with market knowledge, but to effectively adopt a basic high probability strategy, the trader must first identify the type of trade they consider most suited to their trading outcomes.

Broadly speaking, there are four main types of trading: day trading, swing trading, position trading and investing.

Day trading, which often carries the most risk, occurs when shares are bought and sold within one day. Referred to intraday trading, traders can place multiple positions on various markets throughout the day seeking to achieve small (but multiple) increments of profit.

When traders predominately follow a short-term trend (upward or downward), holding open positions for between 2 and 14-days, they are considered swing traders. Position traders work on longer timeframes of between 1 and 6-months while investors are considered long term traders who seek to capture long term growth and profit with receipt of dividends.

Basis of a basic strategy

The basis of any basic trading strategy must include a high probability setup. That is, a binary options trader must believe the trade (or trade direction) has a very good chance of expiring ‘in-the-money’. A high probability setup includes identification of key price action levels including price series (high, low, open, close), support and resistance levels and trendlines, trading volume and price direction.

Gap Trading

Gap trading is a simple and effective price pattern methodology for trading both call and put binary options.

A ‘gap’ is a price pattern (not a technical indicator) which is observed on a daily price chart whereby a stock closes at one price but opens the following day at a higher (or lower) price. A price gap can be as a result of after hours and pre-market trading when the market is closed. Price trades up (or down) during these times and at first trade (market open), opens is at its most recently traded price. A price gap can be due to regular (or irregular) pre-market activity, news announcements, asset earnings, acquisitions etc.

Price gaps commonly appear on daily price charts, but also on minute, hourly and tick charts as well as weekly and long-term charts.

NOTE: A price gap is rarely seen in the forex markets since it is highly liquid and trades 24 hours a day.

Types of Price Gaps

Price gaps often occur during intra-day trading periods, however a high probability setup for binary traders occurs when a gap is as a result of a change in price levels between the close and open of two consecutive days. For this period, there are four basic types of price gaps:

1. Full Gap Up – when the opening price is greater than yesterday’s high price.
2. Full Gap Down – when the opening price is less than yesterday’s low.
3. Partial Gap Up – when today’s opening price is higher than yesterday’s close, but not higher than yesterday’s high.
4. Partial Gap Down – when the opening price is below yesterday’s close, but not below yesterday’s low.

Basic Trading Strategy

For binary option traders, a high probability gap trading strategy can be used to place both call and put trades.

In preparation for a trade setup in any market where an overnight price gap has been observed, a trader must draw a horizontal line at yesterdays close and when the market opens, at the open price.

A binary options trade is place in the direction to ‘fill the gap’. That is, when price retraces back to the previous price action.

When the open price is lower than yesterday’s price, a call trade is placed.

When the open price is higher than yesterday’s price, a put trade is placed.

Question? Will the gap always be filled?

To identify the probability of an opening gap being filled, that is, when price retraces back to the previous price action level we must consider the average size of the opening gap for the asset.

Defined as a function of the prior day’s range, when an upside or downside gap exceeds 40% of the prior day’s range, approx. half of the opening gaps will not fill during that coming day’s price action.

However, when the upside or downside gap is less than 40% of the previous day’s range, 80-90% of the opening gaps will fill during the coming day’s price action.