Binary options are investment vehicles that are geared toward allowing investors to speculate on the direction of an underlying security and earn returns based on tried and true trading methodologies. Similar to other types of investment products such as spot FOREX, stocks and futures, binary options are liquid investment vehicles that can produce robust returns if a trader uses a sound trading strategy to generate consistent gains. The process of trading binary options is far from gambling, and should not be looked at as a game of chance but instead viewed as an investment tools that can generate income when a sound strategy is employed.
Why Use a Strategy
Binary options’ trading differs significantly from gambling, as an investor will prosper with a trading strategy which will give the investor an edge. Binary options’ trading requires skill which makes it different relative to a game of luck. There are a number of trading methodologies an investor can use to trade the binary options market. Each of these strategies requires knowledge of the underlying market, and a strategy that is likely to win more than lose.
Gambling strategies, which are completely predicated on luck, generally focus on risk management techniques to avoid risk of ruin. Binary options strategies are different as they focus on using the benefits of a unique financial instrument to enhance the returns that an investor can garner based on movement in an underlying financial security.
A binary option is a type of option which provides an investor a return based on the movement in an underlying asset such as currencies (FOREX), commodities, stocks and stock Indices. The difference between taking a position in the FOREX market and taking a binary options position in FOREX is that the return is based on a binary option payout which is generally 75-85% of the amount wagered if the currency pair is higher (or lower) than the strike price (the price when the binary options was purchases) when the option expires.
Most binary options are “above or below” options which means that if the price of the underlying asset is above (or below) the strike price (which is the price when the option is transacted) the investor will receive a payout. With this in mind, and investor needs to craft a strategy that will allow him/her to predict the direction of the underlying market between the time the trade is initiated and the time the option expires. Expiration times can vary between end of day, week and month, to hourly or even every 15 minutes. Some binary options platforms even allow investors to start pick the time horizon they want to use and begin the process at their convenience.
Each underlying product that is geared toward binary options moves in a different way and could require a different type of strategy to find the most efficient methodology to generate returns. For example, a stock like Apple might provide the most volatility around an earnings release, while a currency pair such as the USD/JPY is interesting to trade after a monetary policy decision. While there is no set way to trade each underlying product, a technical analysis strategy can be a prudent process to use to initiate binary options positions.
Technical Analysis Strategies
Technical analysis is the study of price action and an attempt to base an investment decision on predicting where a security will go after evaluating historical patterns and studies. Although some perceive technical analysis as a self-fulfilling process, price movements generally conform to a specific flow after moving in a certain pattern. Support and resistance levels are some of the best tools to analyze markets as they provide levels of demand and supply for an underlying product. When resistance or support is breached it forms the basis of a market break-out.
Support levels are areas of market demand were investors are interested in purchasing a security and the demand exceeds the supply pushing prices higher. Resistance is a level of supply were investors are interested in selling a security and supply exceeds demand pushing prices lower.
The chart above shows levels of support and resistance which are measured with trend lines and a moving average. One type of support and resistance trend line is the horizontal trend line which is shown in the graph of the USD/JPY and designated with a green arrow. This horizontal trend line which generated resistance in early April, represented a pivot point, which when exceeded defined a market breakout. When the price of a security such as the USD/JPY closes above resistance (or below support), there is generally follow through which can be used as a signal for a binary option trade. In the case of the green arrow, a trader could place a daily binary options call and generate returns using a horizontal trend line as there trigger.
A second type of resistance line is the downward sloping trend line. This type of trend line connects two or more points and is downward sloping. An example of a resistance trend line is the one designated by the second green arrow that shows the breakout point in August of 2013. A close above this level would likely lead to additional buying of the USD/JPY currency pair.
Support levels can be horizontal trend lines as well as upward sloping trend lines similar to the one in the chart above designated by the red arrow. In this case the trend line connects points marked by the low in June and the low in August. The slope of the upward sloping trend line comes to a point mark by the red arrow. A close below this point would likely see an acceleration of selling of the currency pair.
Support and resistance levels can also be marked by moving averages. A moving average is the average of a specific number of days, which changes with time. For example, a 50-day moving average uses the past 50 trading days to make up an individual point. On the 51st day, the first closing period is dropped from the average calculation making a new point. 50-trading days makes up approximately 1 quarter of trading days and therefore it is a generalization of what has occurred over the past quarter. The 50-day moving average is marked in the chart by a blue arrow and can be used as both a support and resistance indicator.
Support and resistance levels can be used to trigger binary options signals for daily, weekly, month or even intra-day periods. One important idea is that a time period should coincide with the specific binary option tenor a trader is planning on using. For example, if investors are looking for a strategy on daily binary options, they should strongly consider using daily support and resistance levels to generate strategies. If a trader is looking to invest in hourly binary options they should consider using hourly prices to generate support and resistance levels.
Support and resistance can be drawn on using hourly prices similar to the chart above. In this chart, a horizontal trend line is designated by the green arrow, while an upward sloping trend line is marked by a red arrow. The blue arrow reflects the 50-hour moving average.
Sticking to a Plan
A strategy is a plan, is examines the steps that a trader will take in an effort to make money. Gambling on the direction of a market based on gut feel can work for a while, but is likely to fail over the long term as markets are generally unforgiving and move in the direction that will cause the most investors pain. A strategy outlines the plan and can give an investor the edge need to successfully make money in the binary options market.