Binary options strategies
A binary options trader is only as good as the strategy he follows. Finding a strategy that works, and fine-tuning it as you go, will focus your trading, build discipline and help ensure that you win more often than you lose.
In this lesson we will introduce you to three of the most popular and potentially rewarding binary options trading strategies.
We will talk you through how and why they work as well as what kinds of assets, time frames and expirations to use. We’ll also provide you with a concrete trading example for each to show you what a trade looks like.
Strategy No. 1: Short-term Boundary In options before big news events
One way binary options can be used is to predict whether the price of an underlying asset will remain within a specified range for a certain period of time or break outside its boundaries. This approach is known as boundary trading, tunnel trading or range trading.
The strategy we will introduce you to now involves making a short-term bet that prices will remain inside a specified range during a time when you think markets will be quiet and asset prices will trade sideways - for example in the ‘quiet before the storm’ often experienced ahead of a major event or news announcement that the market is waiting for.
How it works
In the run-up to major events like the monthly publication of US Nonfarm Payroll figures, the Federal Reserve’s FOMC meetings and press conferences or interest-rate decisions by central banks, many traders choose to keep out of markets, either because they are nervous of the volatility the event will trigger or are waiting to place trades on its outcome.
This often creates a lull in activity and creates a small range of price action that binary options traders can take advantage of.
How to trade the strategy
- First, choose an underlying asset to trade. Currencies tend to work best with this strategy. It’s also possible with other assets like indices or stocks, in which case you might choose to trade in the run-up to company reports, for example.
- Next, try and identify an upcoming event that you think will have a major impact on the underlying asset you have chosen. Our Economic Calendar outlines some of the biggest.
- Double-check which other factors could also affect that market and make sure there isn’t another major new event happening at the same time. This could seriously blow your strategy off course.
- If you are trading currencies, also remember that you are effectively trading two individual assets, each with a life of their own. So apply the step above to each currency in the pair you trade.
- Look for confirmation that the asset is entering or looks likely to remain within a range and form a view on where you think the upper and lower boundaries of this range will lie. Technical analysis offers a number of patterns or indicators that will help. For example, Bollinger bands or the Moving Average Convergence Divergence (MACD) indicators can help you identify a range-bound market. The appearance of certain kinds of doji candlesticks meanwhile can indicate a trend is about to reverse or that volatility will pick up and the price will break its range, in which case it might be best to avoid this strategy and try another.
- Next, identify the contract type that you will use. You’re looking for a ‘Boundary In’ option – also sometimes called an ‘In Range’ option - with a duration of no longer than 20 minutes and which will expire before the event starts. Not all brokers offer boundary options so make sure you’re using a company that does.
- Price ranges for boundary trades are usually determined by the broker, but occasionally you can choose your own range – pick one strike price above the current price and one below. Make sure the range allows the price plenty of room to move within the anticipated boundaries you identified earlier – you want some leeway. Remember, the tighter the range, the higher the potential payout if you are proved correct, but also the higher the risk that your trade will fail.
- Decide how much capital you want to risk on your trade. Our lesson on money management for binary options will help.
US Nonfarm payroll figures are set to be announced in 30 minutes’ time. The EUR/USD currency pair will be very sensitive to the result and you notice that volatility is low. It’s currently trading at 1.11. Your binary options broker is offering Boundary In options on EUR/USD with a range of 1.109 and 1.113. You buy one that expires in 20 minutes. The market then moves sideways and your option expires with EUR/USD at 1.112 – comfortably inside the range. Your option pays out.
Strategy No. 2: Long-term High/Low options following surprise events
This is a long-term strategy in which you use High/Low options to predict whether an asset price will be higher or lower than a specified level within a pre-determined time period (usually a number of weeks).
It tends to work well following a major, unexpected news event that you think will have long-term repercussions. This could be a pioneering decision by a central bank, surprisingly good or bad corporate results or even a natural disaster.
How it works
When an important news event takes markets by surprise it can trigger some big price moves in underlying assets that are directly affected by the event. If the event looks likely to have a real, fundamental impact on assets that will last for some time it can trigger the start of a long-term price trend.
For example, if war broke out in a major oil-producing region and threatened a big chunk of global crude production, this would usually be positive for oil prices. While crude oil prices would probably jump straight after the news as the market priced in the shock, they may continue to rise – albeit more slowly and steadily – for several weeks as production was actually taken offline and the conflict perhaps even escalated.
Similarly, if the central bank of a major economy announced a big or unexpected interest-rate cut, the currency of that country could enter a prolonged downward trend.
Binary options traders can take advantage of these longer-term trends by forming a view on how far they think prices will rise or fall and how long the trend will continue. They can then use a High/Low option to bet that prices will be higher or lower than a certain point on expiry.
How to prep the strategy
- Unlike Strategy 1, this isn’t a strategy where you can pick an event in advance and plan your trade around it. Rather, you have to act fast in the aftermath of an unexpected event.
- Your first job therefore is to pick one or two underlying assets to specialise in and really get to understand them well. It can help to choose underlying assets that you have some special interest in. For example, if you have worked in a specific industry you might choose to trade shares of companies in that industry or one of the commodities it produces. If you have lived abroad or have family ties with a different country, you may have a more indepth understanding of what affects its currency.
- Because this strategy is long term and involves a simple directional bet, a solid grounding in fundamental analysis is essential before you place your first trade. Apply fundamental analysis to the assets you have chosen to trade so that you understand in advance what are the biggest drivers behind its price, what other assets it is correlated to and what kind of events would be negative or positive for its price.
- Some basic chart work is also essential. Dig out charts that show you how markets behaved following a range of major events in the past. Study what happened to the price of the asset you trade.
- Before you place your first ‘real’ trade, it is also advisable to practise a few times with a demo account. Surprise events aren’t uncommon in financial markets, so simply wait for the next one and then place some dummy High/Low binary trades to experiment with the strategy. Even trending prices experience some volatility that could throw an otherwise winning trade out of the money if you don’t allow enough wiggle room for the price. Practice will help you learn how much to give.
How to trade the strategy
- This strategy relies on a high degree of certainty that an event will create the directional move you are betting on. So as soon as an interesting event occurs, double-check that it is strongly correlated with the asset you trade and big enough to produce the long-term move you need.
- Double-check also which other factors could affect the asset you will trade and make sure it isn’t simultaneously being impacted by another major news event or other head-winds.
- Although fundamental analysis is your best friend with this strategy, you might also want to apply some technical analysis to confirm that a trend is underway before you enter your trade.
- Next, identify the contract type you will use. You’re looking for a High binary option if you think the event will trigger an upward move or a Low binary option if you think it will trigger a downward move. Most brokers offer High/Low options.
- Now choose the maturity and strike price you want. Your broker will probably determine for you which are available. This is a long-term strategy so go for an expiry of at least a week or two, making sure that the trend has time to develop but not leaving so much time that it fizzles out. As with Strategy 1, you also have to leave room for unexpected volatility that could knock an otherwise successful trade out of the money right at expiry. This is perhaps the hardest part of the strategy to master.
- Decide how much capital you want to risk on your trade, remembering that the trade is generally higher risk – with a higher potential payout – the further the strike price from current prices. Our lesson on money management for binary options will help.
Japan’s central bank makes a surprise announcement that it will act to weaken the yen in the long term, for example by selling the currency or lowering interest rates. You now try to identify a currency pair comprising the yen and another currency that is currently fairly strong. You opt for EUR/JPY and buy a High option that expires in three weeks. When the option expires three weeks later, the yen has weakened against the euro and your trade pays out.
Strategy No. 3: Short-term Breakout strategy using previous day’s highs and lows
With this strategy, we again use High/Low options. This time however we are betting that if an asset price breaks through its previous day’s high or low, the price will then experience a large short-term push in the same direction.
How it works
The strategy hinges on the concept of support and resistance. These are levels that, in the case of support, a price struggles to fall below or, in the case of resistance, it struggles to rise above.
Technical analysts have observed that when a price does breach either of these levels, it often suddenly picks up momentum and moves further and faster in the direction of the break.
This is usually because a lot of other traders – range traders in particular - use support and resistance levels to set stop losses so they can automatically exit trades as they move out of the money. A surge of fresh orders often also enters the market at this point, pushing the price further in the same direction.
Binary options can take advantage of this phenomenon by keeping track of the highest and lowest points a price reaches within a single day. The following day they then wait for it to touch these levels again.
If, for example, the price breaks through the previous day’s high (its resistance level), a binary options trader would buy a High option with a short maturity of typically five minutes to bet that the price will be higher when the option expires.
If the price breaches the previous day’s low (its support level), the trader would buy a Low option, again with a short maturity, to bet that the price will be lower when the option expires.
How to trade the strategy
- First, choose an underlying asset to trade. Because this strategy depends on trading having paused overnight, avoid 24-hour markets like foreign exchange. Indices, shares or commodities tend to work well with this strategy.
- Next, identify the previous day’s high and low. You don’t usually need any complex indicators for this – it should be clear from a simple price chart.
- If prices have ‘gapped’ overnight and the opening price on the morning of the day you will trade has already broken through the previous day’s support or resistance levels, do not use this strategy.
- This strategy relies on fast action, so prepare in advance what option you will use. It tends to work best with short time frames, so you want a short-term option with a five-minute expiry. Use a High option if the previous day’s High/Resistance level is breached, and a Low option if the Low/Support level is breached. If you use Japanese candlestick charts, it’s a good idea to wait for a second candle to form that confirms the breach and lets you know there is decent momentum forming.
- As before, decide how much capital you want to risk on your trade. Our lesson on money management for binary options will help.
Germany’s DAX30 index achieves a high of 10.800 and a low of 10.680 on Monday. On Tuesday morning at 10.30am, it breaks the 10.800 level and quotes at 10.803. You buy a short-term High option with a five-minute expiry.
At 10.35am, the DAX30 quotes at 10.823 and your option expires in the money.
So far you have learned that:
- there are 3 common strategies to trade binary options: a short term ‘Boundary In’, a long-term, surprise event, and a short-term Breakout strategy that uses the previous day’s high and low
- these strategies are based on real market dynamics and they repeat over again across different markets
- you can apply any of these strategies with the right practice and preparation